Five Costly Manufacturing KPI Mistakes CFOs Make

Instead of measuring on inventory cost, use tools to forecast the right inventory mix

Published: Monday, August 28, 2017 - 12:02

Being a numbers-driven manufacturing CFO is a good thing—in fact, it’s essential. But as a CFO, you probably know finance and operations more than you know the ins and outs of manufacturing, which can lead you to measuring the wrong key performance metrics.

Here are five costly manufacturing mistakes to avoid.

Mistake No. 1: Using inventory costs as primary driver for manufacturing performance

CFOs often want to drive down inventory costs to free up cash flow. On the surface, that strategy makes sense. However, what happens in the real world is that employees meet the mandate, but miss getting the inventory mix right. Employees may not be aware of all the bill-of-material needs and supplier lead times. Your company risks losing more money than you save when you can’t meet the production schedule because you don’t have the right parts in stock. High expediting costs for parts delivery and then customer shipments are symptoms of having inventory not right-sized to your actual use. Instead of measuring on inventory cost, use tools to forecast the right inventory mix and safety stock you need to keep your plant running smoothly.

Mistake No. 2: Using labor efficiencies as a performance measurement

Labor is cheap! For U. S. manufacturers, labor costs account for less than 10 percent of the overall product cost. Many large corporations use labor costs as a KPI, but for manufacturers, focusing on labor costs does more harm than goods. When manufacturing CFOs try to decrease labor costs, manufacturing is then forced to make product runs in larger batches. Large batch sizes turn raw inventory into finished good inventory too early, consumes warehouse space, and drives up inventory holding costs. Additionally, the company’s agility is reduced by consuming the raw materials early that could have been used to create multiple other products.

To truly transform your manufacturing operations, you should expect a decrease in labor efficiency more than offset gains in profitability. More time is consumed switching between smaller, more profitable jobs.

Mistake No. 3: Making decisions using absorption costs

While absorption costing has its place in high-level reporting, it provides little information that can be used to drive management decision making. In fact, it can be very misleading to report inventory as an asset. For example, if sales hit a slowdown and manufacturing doesn’t respond quickly to reduce production, the inevitable increase in finished goods increases the assets of the company. In reality, this should be seen as a warning sign and not an improvement in financial position. Direct costing or variable costing will provide much deeper insights as to the true cost of your manufactured product.

Mistake No. 4: Choosing suppliers by lowest cost per unit

Low cost is certainly a high priority, but selecting suppliers based only on lowest cost per unit is an extremely poor way to determine where or how you should manufacture product. The risk of comparing low unit cost to standard cost is that while you may “beat your estimate,” there are a number of other variables that must be considered when determining sourcing—like reliability of supplier, quality control, lead times, supplier capacity, and flexibility to meet exceptional situations.

Mistake No. 5: Outsourcing the easy stuff

Anyone can do the easy stuff! That’s true, and that’s why you don’t save much by outsourcing the easy work. If you instead focus on finding a reliable supplier who can do the work that’s highly detailed, takes a long time, or most people don’t like to do, you can create strategic differentiation. Plus, you’ll keep your in-house employees happier.

First published March 1, 2017, on the mcaConnect blog.

About The Author

Doug Bulla

Doug Bulla is the vice president of business development for mcaConnect, where he contributes to the company’s strategic services, customer success, and managed services teams. Bulla has more than 25 years of manufacturing enterprise resource planning and consulting experience across multiple industry segments, such as tier one automotive, biomedical, high-tech electronics, and vehicle assembly.