Manufacturing – Navigating Into the Storm

As of this writing, the U.S. economy has enjoyed a decade of economic growth. The U.S. unemployment rate continued to decrease and is now under 4%, GDP growth has been solid and the Dow Jones Industrial Average increased from under 10,000 to close at 27,000. An impressive run indeed.

As we pass the halfway point in calendar year 2019, however, it appears that this period of economic expansion may be nearing an end. The Institute for Supply Management’s (ISM) Manufacturing Production Index, which is based on a survey of purchasing managers and reporting information about purchase orders, production, employment and more in the manufacturing industry, was at 50.8 for the month of July, which is its lowest level since 2016. And just a few weeks ago, the Fed eased interest rates for the first time since the recession of 2008.

As Michael McKeown, CFA, CPA, of MarcumWealth comments: “There are signals pointing to recession in 2020. The New York Federal Reserve’s recession indicator is flashing. It is based on the U.S. yield curve spread between the 3-month Treasury bill and the 10-year bond. It now shows a 33% chance of recession in the next 12 months. In 8 of the 9 previous times it reached this level, recession followed.”

It remains to be seen whether these data points may be anomalies or a harbinger of something more serious, but the possibility of an upcoming slowdown may be a good reason to take stock of your manufacturing business and how you might prepare to weather the storm.

Develop a Playbook

Over the past few years, you may have been too busy dealing with the challenges of growth to consider how your business might be impacted by a few quarters of contraction. What does your profitability and cash position look like after a 10% downturn in orders? What if that downturn spans multiple quarters or years? Taking the time now to develop scenario analyses may help you determine where to take costs out of your business and, perhaps more importantly, how much and how quickly. Having a realistic plan will help you manage through any downturn in a disciplined manner, while allowing you to continue to effectively serve your key customers.

Preparations may also include an opportunity to improve your current business processes, both on the manufacturing floor as well as in the office. Formalizing policies and documenting procedures may improve productivity, help identify other cost-out opportunities and promote business continuity during periods of workforce reductions.

Protecting Revenue

During periods of increasing revenues, it’s not uncommon for managers to lose focus on margins. Margins may slip for a variety of reasons: costs for expedited shipping resulting from production backlogs, excessive discounts provided by sales personnel, etc. Recovering margins while times are good will likely pay dividends during lean times, especially in terms of pricing strength.

Supply Chain Considerations

This may also be a good opportunity to review your supplier network. If you rely on a single supplier for any of your raw materials, are you confident that they can deliver materials consistently through a recessionary period? Are there other vendors that can provide the same material at a comparable price? Diversification of your supplier network will reduce the risk of disruptions in your supply chain and may allow you to minimize your raw materials stock, making additional capital available for deployment elsewhere in the business.

Access to Cash

Speaking of capital, it’s a good time to consider other ways to improve cash flow. Do you have vendor relationships that allow you to renegotiate longer payment terms? If you offer customer credit lines, have you evaluated your customers for changes in credit risk? Does your business have adequate lines of bank credit? Acting now to either preserve or improve your access to cash during a downturn will provide strategic flexibility to effectively manage your business.

As we look toward the horizon, it’s difficult to know whether the current clouds will pass or develop into a storm. Taking a few steps now to prepare for any outcome will benefit your business regardless of the forecast.

The Marcum Manufacturing and Distribution Group specializes in helping our clients effectively manage through economic cycles.