Best Metrics

5 Key Metrics for Boosting Manufacturing Profitability: Insights from a CPA Industry Expert

Earmark Team · May 30, 2024 ·

As a CPA serving manufacturing clients, you hold the key to unlocking hidden profitability and driving sustainable growth. By strategically managing the following five financial and operational metrics, you can help your clients navigate industry complexities and achieve long-term success.

In a recent episode of the Best Metrics podcast, Leslie Boyd, a principal at CLA’s Manufacturing Industry Group, shared her expertise on the key metrics CPAs should leverage to help their manufacturing clients thrive. With over 15 years of experience in public accounting, Leslie provides valuable insights into using these metrics to identify opportunities and guide clients toward increased profitability and growth.

EBITDA: The Cornerstone of Manufacturing Profitability

Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) is a critical metric that indicates profitability and cash flow health. Banks and investors rely heavily on EBITDA when assessing a company’s creditworthiness and growth potential.

“If you have a negative EBITDA, it’s probably a pretty clear indicator that you are going to struggle to generate cash flow,” Leslie warns. “And quite frankly, if you’ve got banks looking at you and you’re struggling to generate positive EBITDA, they’re going to be hesitant to lend to you.”

EBITDA also plays a vital role in business valuation and succession planning. With an estimated $140 trillion in wealth expected to change hands over the next several years due to the aging baby boomer generation, manufacturing companies must focus on maximizing their EBITDA to ensure a smooth transition and secure the best possible valuation for their business.

To help your clients improve their EBITDA, consider the following strategies:

Identify opportunities to reduce costs through operational efficiencies, such as lean manufacturing practices or automation.
Explore ways to increase revenue through product innovation, market expansion, or strategic partnerships.
Optimize pricing strategies to ensure competitively priced products while maintaining healthy profit margins.
Implement effective financial management practices, such as budgeting, forecasting, and cash flow management, to minimize financial risks and maximize profitability.

Employee Retention: The Hidden Driver of Manufacturing Success

While financial metrics like EBITDA are essential, CPAs must also recognize the critical role that employee retention plays in driving manufacturing profitability.

As Leslie Boyd explains, high turnover rates can lead to many challenges that directly impact a company’s bottom line: “If I’ve got turnover, then I’m retraining people all the time. And if I’m retraining those people, then I probably have a lot of training costs, probably have a significant amount of scrap rate as well. And it could also be indicative of the fact that I’ve got culture issues or other underlying issues going on.”

The costs associated with constantly replacing and retraining employees can quickly add up, eroding profit margins and hindering growth. Moreover, high turnover can lead to decreased productivity, increased scrap rates, and potential quality control issues, damaging a company’s reputation and competitiveness.

To help your manufacturing clients improve employee retention, consider the following strategies:

Conduct employee engagement surveys to identify areas for improvement in job satisfaction, work environment, and company culture. Use the results to develop targeted initiatives that address employees’ needs and concerns.
Encourage open communication and feedback between management and employees to foster a sense of trust and collaboration. Regularly schedule one-on-one meetings and team discussions to ensure employees feel heard and valued.
Invest in employee training and development programs to help workers acquire new skills and advance their careers within the company. Offer a mix of on-the-job training, workshops, and external courses to cater to different learning styles and needs.
Implement competitive compensation and benefits packages to attract and retain top talent. Regularly review industry benchmarks and adjust compensation to ensure your clients remain competitive in the job market.
Recognize and reward employee contributions to show appreciation and boost morale. Implement a formal recognition program that celebrates individual and team achievements and encourages managers to provide regular feedback and praise.

Inventory Turnover: Optimizing Cash Flow and Profitability

Inventory turnover is another crucial metric that CPAs should focus on when working with manufacturing clients. This ratio measures how quickly a company sells through its inventory, providing insight into its operational efficiency and cash flow management.

Leslie shares a powerful case study highlighting the impact of improving inventory turnover on a manufacturing company’s financial performance: “We had a company that really got themselves into some issues post-COVID. And many companies did. They had $50 million of inventory and we worked it down to 10 million. And you can imagine how much cash that unlocks on your balance sheet when you’re able to do that.”

This example demonstrates how optimizing inventory levels can free up significant amounts of cash, which can then be reinvested into the business or used to improve liquidity. By reducing the amount of money tied up in inventory, manufacturing companies can improve their cash flow, reduce carrying costs, and ultimately enhance their profitability.

To help your clients improve their inventory turnover, consider the following strategies:

Implement just-in-time (JIT) inventory management practices to minimize the amount of inventory on hand while ensuring that materials are available when needed. This approach involves closely coordinating with suppliers and streamlining production processes to reduce lead times and minimize waste.
Use data analytics and forecasting tools to predict demand more accurately and avoid overstocking or stock outs. Leverage historical sales data, market trends, and customer insights to develop more precise demand forecasts and optimize inventory levels accordingly.
Collaborate with suppliers to establish more flexible delivery schedules and reduce lead times. Work with key suppliers to implement vendor-managed inventory (VMI) programs or consignment stock arrangements that allow for more responsive replenishment and reduced inventory carrying costs.
Regularly review and adjust safety stock levels to balance minimizing inventory costs and maintaining adequate buffer stock. Use statistical methods to calculate optimal safety stock levels based on demand variability, lead times, and service level targets.
Implement lean manufacturing principles to streamline production processes and reduce waste. Conduct value stream mapping exercises to identify non-value-added activities and implement continuous improvement initiatives to eliminate waste and improve efficiency.

Value Added Revenue and Capacity Utilization: Unlocking Hidden Profitability

Value-added revenue and capacity utilization are often overlooked metrics that can significantly impact a manufacturing company’s profitability. As Leslie Boyd explains, value-added revenue represents the true value that a company creates through its production process, while capacity utilization measures how efficiently a company is using its available resources.

Essentially, value-added revenue focuses on the incremental value a manufacturer generates by transforming raw materials into finished goods, excluding the materials’ cost. By analyzing this metric, companies can identify opportunities to increase the profitability of their products or services by optimizing production processes, reducing waste, or finding ways to add more value for customers.

On the other hand, capacity utilization measures how much of a company’s available production capacity is used at any given time. Many manufacturers operate in a fixed-cost environment, where a significant portion of their costs remain constant regardless of production volume. By increasing capacity utilization, companies can spread their fixed costs over larger units, reducing the cost per unit and improving overall profitability.

To help your clients improve their value-added revenue and capacity utilization, consider the following strategies:

Conduct a thorough analysis of the company’s production processes to identify areas where value can be added or waste can be eliminated. Use tools like value stream mapping and process flow diagrams to visualize the current state and identify improvement opportunities.
Encourage the adoption of lean manufacturing principles to streamline operations and reduce non-value-added activities. Implement initiatives like 5S, kaizen events, and total productive maintenance (TPM) to improve efficiency, reduce downtime, and increase value-added revenue.
Help your clients understand their fixed and variable costs and how they impact profitability at different production levels. Use cost-volume-profit (CVP) analysis to determine the breakeven point and identify opportunities to optimize the cost structure.
Work with your clients to identify opportunities to increase capacity utilization, such as by accepting additional work or optimizing production schedules. Conduct a thorough analysis of capacity constraints and develop strategies to remove bottlenecks and improve throughput.
Assist your clients in developing pricing strategies that accurately reflect the value they provide to customers and ensure adequate profitability. Use value-based pricing techniques to capture the full value of the company’s products or services and avoid leaving money on the table.

Becoming a Trusted Advisor: Guiding Your Manufacturing Clients to Success

As a CPA, your role extends beyond crunching numbers and preparing financial statements. By understanding and leveraging the key metrics discussed in this episode, you can position yourself as a trusted advisor to your manufacturing clients, helping them navigate the complexities of their industry and achieve long-term success.

To become an indispensable partner to your clients, consider the following approaches:

Proactively educate your clients on the importance of metrics like EBITDA, employee retention, inventory turnover, value-added revenue, and capacity utilization. Help them understand how these metrics impact their financial performance and provide guidance on improving them.
Review your clients’ financial and operational data regularly to identify trends, opportunities, and potential challenges. Use this information to provide insights and recommendations that help your clients make informed decisions and stay ahead of the curve.
Collaborate with your clients’ management teams to develop and implement strategies that drive profitability and growth. This may involve working with other departments, such as operations, human resources, or sales, to ensure a holistic approach to business improvement.
Stay up-to-date on industry trends, best practices, and emerging technologies that can help your clients optimize their operations and gain a competitive edge. Share this knowledge with your clients and help them evaluate the potential impact of these developments on their business.
Foster open and transparent communication with your clients, regularly checking in to discuss their goals, challenges, and concerns. By building strong relationships based on trust and mutual understanding, you can become a valuable resource that your clients rely on for guidance and support.

To Learn More, Listen & Subscribe to “Best Metrics”

To learn more about how you can help your manufacturing clients unlock hidden profitability and drive sustainable growth, listen to the full podcast episode of Best Metrics featuring Leslie Boyd. With her wealth of experience and practical advice, Leslie provides a roadmap for CPAs looking to take their manufacturing advisory services to the next level.

How Professional Service Firms Can Leverage Financial Data for Strategic Success

Earmark Team · May 8, 2024 ·

In today’s data-driven business landscape, professional service firms that fail to leverage financial data for strategic decision-making risk falling behind the competition. As the old adage goes, “you can’t manage what you don’t measure.”

In a recent episode of the Best Metrics podcast, Marcus Dillon, founder of Dillon Business Advisors, shared his insights on the importance of utilizing financial data and metrics to guide strategic decision-making in professional service firms. With over 20 years of experience in the industry, Dillon has seen firsthand how leveraging the right metrics can make all the difference in a firm’s success.

Throughout the episode, Dillon emphasizes the role of financial storytelling in interpreting data and communicating insights to clients. He also delves into the specific metrics and KPIs that firms should track, such as liquidity ratios, revenue per headcount, and monthly recurring revenue. By aligning these metrics with the firm’s goals and client objectives, Dillon argues that data-driven insights can translate into actionable strategies that optimize performance and deliver value to clients.

So, how can your professional service firm unlock the power of financial data to drive strategic decision-making? Let’s dive in and explore the key takeaways from Dillon’s insights.

First, Establish a Strong Financial Statement Foundation

When taking on new clients, it’s essential to thoroughly evaluate their financial statements to establish a solid foundation for data-driven decision-making. As Dillon explains, “Once you have full confidence in the numbers… then you can start dissecting and comparing and looking at metrics and KPIs.”

This process involves looking for potential issues and asking questions to verify assumptions. It’s common to encounter discrepancies between a client’s perception of their financial performance and the data. In these situations, it’s important to be prepared to have difficult conversations and explain the reality of the situation.

Some key steps in evaluating financial statements for new clients include:

Reviewing the balance sheet and income statement for any red flags or inconsistencies
Comparing the client’s financial performance to industry benchmarks and their historical data
Asking questions about the client’s business model, revenue streams, and expenses to gain a deeper understanding of their financial situation
Verifying the accuracy of the financial statements through documentation and third-party confirmations

By thoroughly evaluating a new client’s financial statements, you can establish confidence in the numbers and lay the groundwork for effective data-driven decision-making. As Dillon notes, accurate and reliable financial data is the cornerstone of effective strategic decision-making for professional service firms.

Once you have a strong foundation, you can dive deeper into the specific metrics and KPIs that will help drive your client’s success. But without that initial due diligence, you risk making decisions based on faulty assumptions or incomplete information.

The Importance of Tracking the Right Metrics and KPIs

Once you’ve established a strong foundation by evaluating a client’s financial statements, it’s time to focus on the key metrics that will help drive their success. Dillon notes that professional service firms should focus on key metrics to optimize performance and deliver client value.

Some key metrics that Dillon recommends tracking include:

Liquidity ratios: These ratios, such as the current ratio (current assets / current liabilities), can help you assess your firm’s ability to meet short-term obligations and maintain financial stability.
Revenue per headcount: This metric can help you understand how efficiently your firm utilizes its human resources and identify growth opportunities. By tracking this metric over time, you can help clients make data-driven decisions about hiring, training, and resource allocation.
Monthly recurring revenue (MRR): For firms adopting subscription-based models, MRR can provide a more predictable and stable revenue stream, making it easier to plan for the future.
Work-in-progress (WIP): Tracking WIP is crucial for understanding a firm’s financial health and identifying potential cash flow issues.
Billing and collection metrics: Understanding how quickly a firm is billing and collecting payment can help identify areas for improvement and ensure a healthy cash flow.
Profitability metrics: Tracking gross and net profit margins can help identify areas for cost savings and revenue growth.

Professional service firms can leverage financial data to guide strategic decision-making and measure success by tracking the right metrics and KPIs. But as Dillon notes, it’s not just about the numbers themselves. It’s about the story they tell and how you use that information to drive meaningful change in your business.

Aligning KPIs with Business Goals for Maximum Impact

Tracking the right metrics is only half the battle – to leverage financial data for strategic decision-making, professional service firms must align their KPIs with their business goals and client objectives.

To align your KPIs with your business goals, identify your client’s 1-year, 3-year, and 5-year objectives. What are they trying to achieve, and how can you help them? Once you clearly understand their goals, you can select the metrics to help track progress and identify areas for improvement.

One common pitfall to avoid is focusing too heavily on “vanity metrics” like top-line revenue. While these metrics may look impressive on paper, they don’t always provide a clear picture of a firm’s financial health. Instead, focus on sound business metrics like cash flow to owner and net operating profit. These metrics provide a more accurate picture of a firm’s profitability and sustainability.

Some key considerations when aligning KPIs with business goals include:

Identifying the metrics that are most relevant to the client’s industry and business model
Setting realistic targets and benchmarks for each metric
Regularly reviewing and adjusting metrics as needed to ensure they remain relevant and actionable
Communicating the importance of each metric to all stakeholders, including employees and clients

By aligning KPIs with business goals, professional service firms can ensure that their data-driven insights translate into actionable strategies that drive success for the firm and its clients.

Case Study: Aligning KPIs with Business Goals in Action

To illustrate the power of aligning KPIs with business goals, let’s look at a real-world example from Dillon’s firm. One of their clients, a mid-sized law firm, had been tracking top-line revenue as their primary metric for years. While their revenue had grown steadily, the firm’s partners consistently worked long hours and felt overwhelmed.

By digging deeper into the firm’s financial data, Dillon’s team identified a key issue: the firm was taking on many low-margin cases that were consuming a disproportionate amount of time and resources. By shifting its focus to metrics like profitability per partner and average case value, the firm could make data-driven decisions about which cases to pursue and how to allocate resources more efficiently.

As a result, the firm was able to reduce partner workload while maintaining profitability, ultimately leading to greater satisfaction and work-life balance for the partners. By aligning their KPIs with their business goals, the firm achieved success on its terms and created a more sustainable model for the future.

Mastering Liquidity and Cash Management for Financial Stability

Effective liquidity and cash management are essential for professional service firms to maintain financial stability and make strategic decisions. As Dillon points out, “I personally don’t want more than a 50/50 split in cash and accounts receivable, just because I want the client to be more in control of their money than their customers’ financial habits driving the decisions of our client.”

One key metric to track is the current ratio (current assets / current liabilities). Dillon recommends maintaining a current ratio of 2:1 to ensure sufficient cash for opportunities and expenses. This means the firm should have two dollars of current assets available for every dollar of current liabilities.

Another important aspect of cash management is monitoring accounts receivable aging. Dillon suggests a 50/50 split between cash and receivables to maintain a healthy balance. This allows the firm to have enough cash to cover expenses and invest in growth opportunities while ensuring that receivables are being collected on time.

To maintain accurate financials and avoid overestimating available cash, it’s important to write off bad debt regularly. This helps to keep the firm’s financial statements accurate and up-to-date and prevents the firm from making decisions based on inflated cash balances.

Finally, implementing policies and procedures that encourage faster invoicing and payment collection can help to improve liquidity and cash flow. Some strategies to consider include:

Offering incentives for early payment, such as discounts or loyalty programs
Implementing automated invoicing and payment systems to streamline the billing process
Regularly following up on overdue invoices and establishing clear payment terms with clients
Conducting credit checks on new clients to assess their ability to pay on time

The Benefits of Effective Liquidity and Cash Management

By mastering liquidity and cash management, professional service firms can reap several benefits, including:

Improved financial stability: With sufficient cash reserves and a healthy balance between cash and receivables, firms can weather unexpected expenses or slow periods without experiencing financial strain.
Greater ability to invest in growth: When a firm has strong liquidity, it can more easily invest in new opportunities, such as expanding services or hiring additional staff, without putting undue stress on cash flow.
Enhanced decision-making: With accurate, up-to-date financial information, firms can make more informed decisions about resource allocation, pricing, and other strategic matters.
Stronger client relationships: By implementing policies and procedures that encourage timely payment, firms can foster stronger, more positive relationships with clients and avoid the strain of overdue invoices.

Effective liquidity and cash management is not a one-time task but an ongoing process that requires regular attention and adjustment. By staying on top of key metrics and implementing best practices, professional service firms can ensure they have the financial stability and resources necessary to make data-driven strategic decisions and achieve long-term success.

Putting It All Together: Leveraging Financial Data for Strategic Decision-Making

Throughout this article, we’ve explored how professional service firms can leverage financial data to drive strategic decision-making. There are many pieces to the puzzle, from tracking the right metrics and KPIs to aligning those metrics with business goals and mastering liquidity and cash management.

But how do you combine it to create a cohesive, data-driven strategy? Here are a few key steps to consider:

Start with your goals: Clearly define your firm’s goals and objectives before diving into the numbers. What are you trying to achieve, and how will you measure success? By starting with your goals, you can ensure that your financial data is used to support your overall strategy.
Identify your key metrics: Once you have your goals, identify the key metrics that will help you track progress and make informed decisions. This may include a mix of financial metrics (such as liquidity ratios and revenue per headcount) and non-financial metrics (such as client satisfaction and employee engagement).
Establish a data-driven culture: To leverage financial data for strategic decision-making, it’s important to establish a culture that values data and encourages its use at all levels of the organization. This may involve providing training and resources to help employees understand and use financial data and regularly communicating the importance of data-driven decision-making.
Use financial storytelling to communicate insights: As Dillon notes, financial storytelling is a powerful tool for communicating insights and driving action. By weaving together financial data with non-financial factors and presenting it clearly and compellingly, you can help stakeholders understand the story behind the numbers and make more informed decisions.
Continuously monitor and adjust: Finally, it’s important to remember that leveraging financial data for strategic decision-making is an ongoing process. Your metrics and strategies may also need to change as your firm grows and evolves. By continuously monitoring your data and adjusting your approach as needed, you can ensure that you’re always making the most informed, data-driven decisions possible.

Unlocking Your Firm’s Potential with Financial Data

As we’ve seen throughout this article, there are many pieces to the puzzle regarding leveraging financial data effectively. From tracking the right metrics and KPIs to aligning those metrics with business goals, mastering liquidity and cash management, and using financial storytelling to communicate insights, there is no one-size-fits-all approach.

But by taking a holistic, data-driven approach to strategic decision-making, professional service firms can unlock their full potential and achieve new levels of success. Whether you’re a small, local firm or a large, international organization, the principles of leveraging financial data remain the same.

To learn more about how your firm can leverage financial data for strategic decision-making, be sure to listen to the full episode of the Best Metrics podcast with Marcus Dillon.