If you have been in business for a while, this fact won’t surprise you. Less than 50% of manufacturing startups make it past the four-year mark. This is not usually because of the owner or founder’s lack of knowledge in the industry. Instead, it most likely comes down to cash flow.
Simply put, cash flow is the total amount of money being transferred into and out of a business. If your available money grew during the period, you have positive cash flow. If you have less than you had at the beginning of the period, you have negative cash flow. Too many periods with negative cash flow can be a sign that your business might be in danger of running out of cash.
What impacts your outgoing cash flow (accounts payable)?
Payroll and benefits
Equipment lease or loan payments
Rent or mortgage payments
Material and component purchases
Software and equipment upgrades
Inventory management, storage, and taxes
Other fees, permit costs, etc.
What impacts your incoming cash flow (accounts receivable)?
Customers paying for goods and services
Investment income if you have interest-bearing accounts
To give you a little insight into cash flow, here is an example:
A customer asks you to quote 50 widgets. You analyze the time it will take to manufacture those widgets. You add material and overhead costs, as well as transportation expenses and profit. You give the customer the quote. He agrees to the terms and has you build 50 widgets. You order the materials and tooling, start building the fixture, and purchase other things you need to complete the job on time. These items all cost you money, and most of your suppliers have 30-day net agreements. It takes another four weeks to make those 50 widgets. Once they are complete, you ship them to the customer with an invoice.
The total time is over two months. In the meantime, you must pay for materials, make payroll, pay the utility company, etc. That’s a lot of money going out the door, and nothing coming in. While you are waiting for your customer to pay, you take on other jobs and cover the related expenses. Now, you have no cash available to pay your other bills. You are in trouble even though you didn’t do anything wrong.
To protect yourself, you can put a few safeguards in place.
Establish a budget
Set tax and fixed cost dollars aside
Make sure you price your widgets correctly to include all operating and fixed costs, as well as a satisfactory profit margin
Negotiate 45-day or longer payment terms with your suppliers
Ask your customers to make a down payment of 25% or more
Set up payment plans with your customers (e.g.,10% one week before the project starts, another 20% due at the beginning of the project, etc.)
Set 10-day payment terms with your customers
Offer a 5% or higher discount if the invoice is paid in full within 10 days
In addition, you can do the following to keep you fixed costs down.
Don’t have excess capital investments
Make sure you don't have unnecessary equipment that is not paid for
Ensure your existing equipment is utilized to its full potential before buying more capacity
When buying equipment, see if used machinery is available
Investigate if current machinery can do the job before adding special equipment
Use Lean manufacturing practices
Single piece flow not batch manufacturing
Use Takt time manufacturing principles
Manage your inventory
Don’t overstock raw material and components
See if your customers will buy the components for you
Even when you are a small or midsize company, or just starting out, it’s important to pay close attention to your cash flow. If you do not have a 100% grasp on your cash flow, you might want to consider some of the following ideas:
Take classes in business finance
Hire an accountant
Contract with a consulting firm
Join a trade association (resources)
Set money aside to ensure you can pay incoming bills
You might have started your manufacturing company because of your passion for machining or assembling parts, but you still need to focus on the basics of business. You can’t have expenditures that are larger than your income. Some of the simple ideas above can make it easier for you to stay ahead of cash flow problems.