1 key metric helps manufacturers protect margins

The economic turbulence of recent years bombarded manufacturers with challenges: Supply chain disruptions. Workforce issues. Inflation. The list goes on.

Business leaders have had to be nimble and adaptable in response. But while making all these adjustments, some manufacturing companies might have lost a good handle on one of their most critical metrics: The true expense cost of producing their products.

Inventory costing

Understanding and monitoring your inventory cost is essential for manufacturers. That’s particularly true during an era of rising labor costs, material costs and incoming freight charges/surcharges.

Knowing your true cost is an essential step to making pricing decisions while ensuring profitability, retaining customers and potentially growing your business. (This advice translates to many other types of businesses, as well.)

A comprehensive look

Fully tracking inventory costs involves taking a comprehensive look at all expenses related to sourcing, making, storing and distributing products.

That means going beyond just direct costs.

The cost of inventory obviously includes the direct materials and labor used in the production process, but let’s dig a bit deeper. There also are indirect costs associated with production such as:

  • Your product is manufactured with production equipment. Has your company captured the cost of the depreciation, repairs and maintenance of that equipment in product costs?
  • Your company needs a facility for production and product storage. Have you fully captured the costs related to those components, including insurance costs, property taxes and depreciation? How about the utilities to keep the lights on and to run the equipment?
  • Staff are needed to receive the product components into your warehouse facilities for production, storage of the product and later preparation to ship the product to customers. Has your company factored in these indirect labor costs? How about the production supervisors, who do not directly build the product but provide oversight of operations?

The true expense cost for products likely has been impacted by inflation, supply chain issues and other developments in recent years. Operating on outdated cost information can put a manufacturer at a competitive disadvantage and affect profitability.

It’s critical to understand how economic factors have impacted inventory cost components. With that information, manufacturers can make informed decisions regarding which products to emphasize, which to discontinue and how to adjust pricing.

Real world example

Cost miscalculations can lead to financial strain. Underestimated costs can lead margins to dwindle, making it difficult to cover operating expenses, grow your business or weather additional economic upheaval.

In 2022, a midsized Iowa manufacturer who works with Honkamp, P.C. saw firsthand the benefit of keeping a close eye on the true cost of its products.

The company’s regular review of those costs highlighted vendor pricing increases and led to multiple price changes for the company’s key products. This process allowed the company to quickly adapt to protect its margin.

Beyond pricing

The implications of poor inventory costing extend beyond pricing woes.

They include improving vendor selection. Understanding and monitoring your inventory cost can result in the identification of unusual or unexpected pricing trends from company suppliers. This can be a signal to explore alternative suppliers or diversification of your supplier base.

A complex challenge

Working to determine your products’ true cost can be a complex challenge. But it’s a critical issue, so consider reaching out to a financial expert to ensure you’re on the right track.

And remember that successful manufacturers don’t determine their true cost just once. They have ongoing monitoring in place, so they can quickly adapt and adjust when the next curveball is thrown their way.