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Manufacturing Profitability Concepts- Explained (In-Depth)

There has never been a time when manufacturers have been more critical of ensuring that their products reach customers quickly, at a low cost, and with the highest possible quality. Nevertheless, it’s unfortunate that not every unit that leaves the factory is pristine.

Manufacturers must return to the drawing board and ensure that their efforts are centered around three key metrics: time-to-market, quality, and cost.

Only then will they be able to address this discrepancy head-on. When brought together, these three components create a synergistic effect that ignites the revenue and profitability that each product brings in for the company.

Top-performing manufacturers aim to achieve greater efficiencies across the board by emphasizing the time-to-market, quality, and cost metrics. Nevertheless, not every company can be considered a “Top Performer.”

According to the data provided by Aberdeen, only one in three products achieve manufacturing objectives for time-to-market, quality, and cost. Furthermore, the likelihood of five out of six products achieving these objectives is only 5%.

Companies can gain valuable insights into the strategies and technologies they should implement to boost their ability to deliver the desired results by looking to their peers who are already achieving high levels of success in their respective industries.

Manufacturing Profitability

Manufacturing profitability is a term used to describe a manufacturing company’s overall financial health. It considers several factors, including revenue, expenses, and net income.

There are several different ways to measure manufacturing profitability. One standard method is to take the company’s total revenue and subtract the total expenses. This will give you the net income of the company.

However, this method does not consider the company’s different types of revenue and expenses. For example, a company might have high sales but low margins. In this case, the net income would be artificially low and not accurately represent the company’s financial health.

Another way to measure manufacturing profitability is to look at the operating margin. This is the amount of revenue that a company has after subtracting the cost of goods sold. The operating margin can be a good indicator of how efficient a company is at manufacturing its products.

Finally, you can also look at the net margin. This is the amount of revenue that a company has after subtracting all of its expenses. The net margin is a good indicator of a company’s overall profitability.

All three of these methods have their advantages and disadvantages. The best way to measure manufacturing profitability is to use all three methods and compare the results. This will give you the most accurate picture of a company’s financial health.

Regarding manufacturing profitability, there are several different factors you need to consider. These include the cost of goods sold, the operating margin, and the net margin. Considering all these factors, you will get a good idea of a company’s financial health.

The Relationship Between Costs and Profits in Manufacturing

The most apparent consequence of inaccurate costing is that it leads to decisions that are not optimal. When you inflate the price of a product, you also inflate the number of units you have in stock. If you overstate your inventory, you will overstate your profits. This may also affect taxes, lending, reporting, and other areas.

When too much cost is assigned to a product, it can result in overpricing, affecting market share if a competitor offers their product at a lower price.

A distorted margin could be the result of under-assigning costs. You may believe your product’s selling price is sufficient to cover all your costs when you’re actually losing money.

When discussing the pricing of products and ways to improve the accuracy of our estimates, we should investigate the costs of materials, labor, and overhead.

Manufacturing Material Costs

A more accurate cost estimate can be created by determining how much of each material is required for production and then using precisely that amount.

If, for example, you believe you have a 5% scrap rate, but in reality, you have a 10% scrap rate, then you are utilizing more materials than you believe. This will have repercussions for inventory management and purchasing in the future, wreaking havoc on your profitability.

Manufacturing Labor Costs

You will notice a distortion in pricing if the production of something is taking significantly longer than you had anticipated when labor or automation costs rise, a company’s ability to turn a profit drops.

Because of this, it is critical to maintain a realistic perspective on what is required for production and to factor those costs into equations that determine a company’s level of profitability.

Manufacturing Overhead/ Manufacturing  Costs

The overhead includes all the costs associated with supporting the manufacturing operation. Examples include the monthly rent and the leasing of equipment.

Direct labor, machine hours, and square footage dedicated to production are three key levers that can manage overhead costs effectively. These three factors can directly impact a company’s profitability, which is an important consideration.

Improving Margins Obtained from Customers to Raise Profits

Ensure that your customer margins allow for maximum profitability by managing accurate costing. This will allow you to maximize your profits. It’s a common misconception that revenue equals profits, but most businesses profit from the top 20% of their customers. It’s possible that the top 20% of customers responsible for generating revenue aren’t your most profitable.

When conducting a profitability analysis, it is necessary to have a solid understanding of the Selling, General, and Administrative expenses incurred for each customer. This can be a complex study, but it is well worth the effort if it helps you make better business decisions to increase your profits.

Understanding customer margins, costing, profitability, and where to concentrate one’s efforts should be the primary responsibility of a capable CFO with extensive manufacturing industry experience. Your manufacturing company will be able to determine the biggest levers for profitability and how it can save costs and increase profit margins if it looks beyond revenue and digs into the fine details of manufacturing.

How to get started with improving manufacturing profitability?

Even though an improving economy has improved manufacturing companies’ operating environment, strong management teams should always be focused on improving their margins. Increasing a company’s margins and improving its profitability can be accomplished through the following four steps.

1. Start by analyzing the pricing strategy the manufacturing company uses for those products and/or services with the narrowest profit margins

Think about why the product or service does not bring in more money. Is there a technological solution that could improve the effectiveness of the production process? Is there a way to change production without impacting the final product’s functionality? Is it possible to increase the value of a product before it is released onto the market?

Requires this product shifted, or has a rival company introduced a more advanced model of the same thing? Make it a point to zero in on particular transactions involving customers and products to locate the areas where your business is losing money.

It is essential to have the highest level of accuracy during the analysis to ensure that any potential solutions will also have the same level of precision. If the transactions don’t answer the immediate questions, you should consider conducting a customer survey to get the data you need to make educated decisions.

2. Determine the customer base and demographics of the particular product

Customers should be classified according to the importance they attach to the goods produced by the manufacturer. The following step is to establish whether or not customers consider this product a luxury item and whether or not this perception shifts depending on the demographics of each subcategory and the influences of the market competition.

For instance, a customer who purchases an optional machine component will have a lower tolerance for an increase in the machine’s price. However, a different customer who uses the product as an essential component of their production process will be more tolerant of price increases, mainly if they are comparable to competitors’ prices.

After determining these categories and assigning customers, the manufacturing company should conduct an analysis based on the first two steps and then use that analysis to establish relevant, specific pricing and negotiation guidelines.

3. Establish sales negotiation parameters and regularly reexamine the pricing model

While there should be some leeway in pricing, there should also be specific points at which the deal is terminated due to its impact on margins. Make the sales team aware of these limits by publishing them, and check to see that the pricing structure takes into account any commissions that may be applicable.

Even though some markets are more unstable, businesses should look for specific turning points and devise strategies to analyze their pricing structures.

Profitability is directly tied to the speed with which one can respond to the strategies employed by one’s competitors, regardless of the state of the economy or the regulatory environment.

Manufacturing Profitability Concepts- Explained (In-Depth)- Recommended Reading

  1. Manufacturing Cost Accounting Assessment- Is Your Team Competent?

  2. Leading The Drive For Good Strategy Execution And Operational Excellence

  3. The Essential Guide to Manufacturing KPIs

  4. Why Isn’t Overstocking Warehouses An Effective Solution?

  5. Manufacturing Profitability – Growing Sales

Updated: 5/21/2023

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