Manufacturing Industry: Mining Data from Your KPIs to Help Prepare for Recession
Cash Flow Forecasting Key to Weathering a Downturn
Manufacturing company owners and managers rely heavily on the data drawn from key performance indicators (KPIs) to make sound decisions for their businesses. Reviewing real-time data regularly, with monthly or quarterly reporting of the most important KPIs, helps identify areas where weaknesses may emerge before they become significant problems.
Ideally, business leaders also use KPI data to benchmark their companies’ performance against other manufacturing companies in their industries or regions.
But KPI data and benchmarking take on a different level of importance in an economy that may be headed for recession, and business owners should be looking at how the data they review regularly can help them prepare for an economic downturn.
Is a Recession Coming?
A recession is a significant decline in economic activity that lasts for months or even years. A conventional definition holds that an economy has entered a recession when it has experienced two consecutive months or more of negative gross domestic product (GDP) growth. But other factors may be present, including rising unemployment, falling retail sales and contracting measures of income and manufacturing.
Economists differ on whether the U.S. will enter a recession soon, but with 2023 forecasts estimating economic growth in the range of -0.4% to 1.2%, at least a mild recession may happen. Some economists have started using the term “pasta bowl recession,” suggesting a recession that will be shallow but potentially long in duration.
Economists focused on Kansas manufacturing expect a shallow recession that will likely last less than one year. Whether the economy technically enters recessionary territory, continuing supply chain issues and labor shortages present challenges for many businesses that fall to the bottom line. For example, if you can’t get raw materials and you can’t hire labor to work the shop floor, the financial impact may be as bad as a recession.
Using KPI Data in New Ways
Preparing for recession requires a careful look at current KPIs and assessing how the data can be used in new ways to help ride out the rocky economy. For most manufacturing businesses, KPIs include watching gross profit margins, net working capital, inventory turnover, growth rate, return on assets and current ratios such as assets over liabilities and debt to equity. Also included are the average days on accounts receivable and accounts payable.
Different businesses use their KPI data differently. Gross profit margin data can help determine pricing strategy, and net working capital helps make financing decisions. For example, if you need to buy a new piece of equipment, will you finance it or make the purchase with cash on hand? The current ratio can also help with decisions about making capital expenditures.
During non-recessionary economic times, with low-interest rates, these data may suggest that financing is a good option for making capital expenditures. However, financing may not be the best option with a possible recession and interest rates rising rapidly today.
Cash Flow Forecasting
During a recession, even a mild one, shifting your focus to cash flow forecasting as a top KPI can help maintain performance. Having a strong balance sheet and steady income, with a modicum of growth, if possible, is a reasonable strategy.
So, working your KPIs into your cash flow forecasting and budgeting, and using different scenarios to anticipate potential pitfalls, can help maintain a steady performance.
Despite a possible recession ahead, the news is not all bad. Most regional manufacturers have had strong years since the nation started pulling out of the COVID-19 pandemic. Supply chain issues are still vexing, but many manufacturers have expanded their customer bases, and some raw materials and component parts that used to be sourced in China are now produced in the U.S. Nonetheless, recessions have a way of impacting even thriving industries, and business owners must be prepared. Generally, manufacturers should focus on cash flow forecasting with specific approaches:
- Projections should look out at least 16 months. During a recession, projecting cash flow out over a more extended period is key to realistic budgeting.
- Run multiple scenarios on your cash flow forecasting, which will help determine strategies for dealing with best-case and worst-case outcomes.
- Look at operating costs and divide them into three buckets – costs related to what you are producing, indirect costs associated with marketing, IT and other ancillary areas and human capital costs such as salaries and HR. If you have to cut costs, seeing exactly where the direct costs are and what the impact would be on production will help guide the decisions.
- Assess other strategies for helping with cash flow, such as offering customers discounts for early payment or slowing down your payments to vendors.
- Watch debt and don’t take on additional unless necessary.
- Many business owners pull back on capital expenditures during recessions, but some expenses may help strengthen cash flow if they create more efficiency, especially if the labor market continues to be tight.
- Look at your processes and procedures to ensure your business is as lean as possible, including operations, technology and ancillary areas.
- Evaluate your product and service mix, which can help direct investment and resources to the most profitable lines.
While many of these strategies may be helpful during non-recessionary times, they are crucial during a recession and can lay the groundwork for improved performance and decision-making when the recession is over. Contact your Adams Brown advisor to discuss how you can prepare your business for a potential recession.