Doug Houser:
From Rea & Associates studio, this is unsuitable, a management and financial services podcast for entrepreneurs, tenured business leaders and others who are ready to look beyond the suit and tie culture or meaningful measurable results. I'm Doug Houser. On this weekly podcast thought leaders and business professionals break down complicated and mundane topics and give you the tips and insight you actually need to grow as a leader while helping your organization grow and thrive. If you haven't already, hit the subscribe button so you don't miss future episodes. And if you want access to even more information, show notes, and exclusive content, visit our website at www.reacpa.com/podcast, and sign up for updates. Continuing to manage your organization's costs can be difficult to keep top of mind, especially with everything else going on. COVID-19, a troubled economy, figuring out how to bring your employees back to work.
You have enough on your mind, and it can be tempting to when it comes to managing your costs to take the set it and forget it approach. But today we're going to talk about why that's not the best course of action. Understanding your true costs is just one of the ways you can reveal major gaps in your business. And as you know, it's never been more important to trim the fat than it is today. Sure, breaking down your product and labor costs can be a daunting and mundane task, but with the right tools and expertise, it can actually result in some pretty significant savings. Today, Andrew Geiser, a manager at Rea & Associates is here to explain how you can go about identifying potential leaks in your cost structures. This is a pretty widespread problem. So I'm anxious to get started. Welcome to unsuitable, Andrew.
Andrew Geiser:
Thanks, Doug. It's really good to be here. Get on unsuitable and have a chat with you.
Doug:
Yes. Glad to have you. We should have had you on long ago. Now you've got just a varied experience. Perhaps you can talk about that a little bit? You spent some time in manufacturing yourself before for joining Rea. Talk a little bit about the perspective that gives you.
Andrew:
Yeah, so I spent about two and a half years in a manufacturing facility that was fairly large, about 500 to 600 employees, depending on the time of year. And so yeah, that really gave me a chance to see firsthand the impact that knowing costs and understanding costs can have on an operation and just to get some experience to see how that's done, how costs are analyzed, managed, and then ultimately how they roll up into financial statements and ultimately decision making.
Doug:
So oftentimes I know when I was in banking, and not that I dealt with a whole lot of manufacturers, but talking to my colleagues that did, they often would get frustrated. It felt like there were certain manufacturers that didn't understand or know their own true costs. Do you find that to be the case across the industry to some degree?
Andrew:
Yeah, I would say so. Especially in a lot of our client base here at Rea, on the smaller business side there's just not the resources there from an overhead perspective to support someone dedicated to that.
Doug:
Mm-hmm (affirmative).
Andrew:
Not that it really would always take a full person to do that, but there's just not that level of detail businesses are getting into when they're along a little bit of the smaller side.
Doug:
Yeah. So I think back to my days as studying cost accounting, 30 years ago, of course I always found that to be very, very difficult. So what are some of the challenges with getting cost counting integrated into your own accounting system if you're an owner managed business?
Andrew:
So I think the first one that I see is just getting over the hurdle that it is confusing. I always tell people that learning it from a book is completely different than real life, and that you can study formulas in a book all you want, but when you actually get out in an operation and you see it and you think about what's happening and how product is moving it usually tends to make fairly a lot of sense at that point. So that's the first thing that I see. And then the second one is really seems like just with the somewhat sophistication of accounting systems these days, obviously QuickBooks, there's a little bit more of a simpler system, but anytime you get into maybe a more robust ERP where there's absorption or where it's automatically booking costs, you have labor overhead rates, understanding how the system works is usually one of the first barriers that I find when I go out and I talk to clients.
Doug:
So where do you typically see that break point where somebody is ready to have a more sophisticated type of system like that and really take advantage of it? Is there a rule of thumb in terms of employees or volume or anything like that?
Andrew:
I don't know that there's really a general rule of thumb. I think it's more so just whenever you get to the point where you're really having to track inventory, track your costs, because a lot of times maybe you have different product lines or different segments of your business where you really need to know what the costs are in each segment or a product line. When you're getting to that point, that's probably when you really want to start to think about, "What's your system doing and do I need to give this more attention?"
Doug:
Gotcha. Gotcha. So when you go visit a client or prospective client, I know one of the things obviously you like to do is to go through the facility and get a feel for what's going on. So talk to me a little bit about how that works when you go through a facility. What do you notice? What do you see? What sticks out to you?
Andrew:
So one of the first things that I'm looking for when I go through a facility is what kind of a process is it? Is it more of a batch process or a job shop, or is it more of a continuous process? And then the second thing that kind of plays off of that is, is it more of a labor process where it's driven by the labor or is it more of a capital process where you have machines or robotics doing a lot of the work? Because then that's going to lead into whether or not you want to look at machine hours or labor hours down the line when you start looking at labor and overhead beyond materials.
Doug:
Okay. So if it's more labor intensive, then obviously the labor hours is a bigger factor. So ultimately the end game, whether you're capital intensive or labor intensive, either way, or I guess job shop or more process driven, is the goal here to try to get at how you can identify or inefficiencies within each of those segments. What's the end game, I guess, with trying to understand it?
Andrew:
So usually the end game, especially when someone's just trying to understand what their true costs are, what their labor rate is or overhead rate, is trying to figure out well, what's controlling the output of your process? Because if you think about, you may hear the term overhead rates, labor rates, those are on an hourly basis. And so when you're looking at it, you really want to know how much product can you get out the door in an hour? And if it's a machine that's controlling that, you probably want to think about basing that rate and assigning your costs based on machine hours. If it's more labor driven and labor intensive, where if you peel a couple people away from your process and your output is drastically reduced, then that's what's controlling your output and that's usually then where it probably makes more sense to look at a labor hour approach. So that's really what we're trying to get at there.
Doug:
I've been through, within the last, say, six to eight months too, manufacturing companies because they happen to manufacture construction-related products. And I'm just fascinated. I'm used to visiting job sites, construction job sites and all that. But I'm fascinated by some of the knowledge and also lack of knowledge that I see in companies that are even 20, 25 million a year in revenue and still, in essence, operating largely on a cash basis. Do you see much of that out there? It always interests me to see what people experience.
Andrew:
Yeah, no, I would echo that as well. In fact, that was probably one of the biggest things that surprised me as I started doing some of this work here at Rea, is just some of the lack of ability to know what true costs are. And I think just in general, a lot of people may be surprised at the way it's [inaudible 00:09:42] in a lot of ways to fly by the seat of your pants, from that standpoint. So yeah, that's definitely something I've experienced, and from the little furniture shops that we get into here in Holmes County, all the way up to the 50, 60, $70 million businesses.
Doug:
Yeah, it is amazing. And I know we had one where we dug into it a little bit on behalf of a third party client, and we started to ask them while I was present about their overhead rates and things like that. And they're like, "Oh yeah, we've used the same overhead rates since literally 1992. And then we just plug some stuff into it." And I'm thinking, "Holy cow, you have no idea what you're [inaudible 00:10:25]"
Andrew:
Yeah. Yup, yup. That's more common than probably most people would think. And when times are good, you're probably all right. But when it comes down to it, whether it's a crisis here, like COVID or something like that, having those rates set and in stone and understanding them for a couple of years really helps because then they can really help you see where you're going.
Doug:
And I guess my point in bringing that up is if you're a company in that situation, don't be afraid to speak up because there are a lot of companies that are in that boat. So when you encounter someone like that, where do you start with something like that? Because it can seem I'm sure. So daunting to the client.
Andrew:
Yeah. Well that's honestly one of the first things I'll tell them is, "You're not alone, so don't be embarrassed. Don't feel bad that you've gotten to that point because, yeah, it is more common." But the next thing I usually try to do is kind of go back to just breaking costs up between materials, labor, and overhead, and usually go straight to the P&L. And this is probably more so if it's a smaller client, if it's a little bit larger, we'll obviously dig in into more account detail and that kind of thing.
But really just breaking those, those buckets up, that I call them, because most people, what I found, have a pretty good handle on their material costs. If you're making a chair, it's not too difficult to know, "I bought a piece of wood for $10, I'm going to use half of it for this chair. It's five bucks, a little bit of scrap." Most people can get that where it really gets tricky is with labor and overhead. And what I find is most people don't understand the amount of overhead, how that affects what their bottom line ends up being at the end of the year and getting that to their products.
Doug:
So trying to figure out your true labor hour cost and your machine hour costs, and trying to assign those to specific product lines, things like that.
Andrew:
Yep.
Doug:
So what's that process like for you, if you're consulting with a client to try to dig underneath the surface to get there with that? How long does that take roughly, or what's the process like for folks?
Andrew:
Gotcha. Yeah, no, a lot of it depends on how big the client is. Obviously the bigger, the longer it takes. And also kind of what their process is now. And that's usually where I like to start. What are they doing now? Because a lot of times what I've found too, is a lot of times the general methodology or process doesn't really need to change, it's just a matter of thinking through, what are all of your costs? And making sure they're all accounted for. So I usually ask to see what they're doing now first and I'll review that. And then, like you said earlier, I try to go out to the client, meet with them, talk through questions I come up with as I review their stuff.
And then in my mind, most importantly, is get a tour so I can see the process and see what's going on, how many manufacturing lines do they have? How many machines do they have? So then when we go back and we're trying to develop a model to do labor and overhead rates, I can know, does this make sense with what's actually happening out on the manufacturing floor? Because at the end of the day, that's what we're trying to model, is what is actually happening out there and making sure that our rates and our costs and everything that we're doing lines up with that.
Doug:
Yeah. And then ultimately, you're providing them a tool so that they can monitor and try to control their costs, correct?
Andrew:
Yep. Yep.
Doug:
The end game is you want to know what your product costs so you can look at efficiencies perhaps. Or if you're looking at new business, you can understand, "Okay, what's the potential impact?" And all of those things.
Andrew:
Yep. And the other thing that a lot of people will use their costs for is to base their pricing off of. They'll develop their costs and then they'll either just throw a set margin on that or they have a target margin that they want to get when they sell it if they're quoting jobs or whatever. And so what happens is if they start using some bad costs or some bad rates, they can start to potentially under quote a lot of work. And they may be busy and doing a lot of work thinking they're getting good margin, but at the end of the day they're not because their costing assumptions and their rates and stuff are a little bit outdated.
Doug:
Yeah. And as you bring that up, that's kind of scary, because that can mushroom quickly all of a sudden, if you take on a big customer or if you have a big customer where your costs aren't properly identified, like you said, you're doing a lot of work, but losing money in volume doesn't make that up.
Andrew:
Yeah, yeah, yeah. Volume doesn't help when you're losing money.
Doug:
Do you find when you help clients go through this process, do they start to reevaluate their own customer base perhaps to some degree as they start to think about, "Okay, where's my best potential?" Does it get that granular?
Andrew:
Some do, some do. I can give you an example of that one. I had a pallet manufacturer that made various sizes and realized when we got in there, he was using the wrong driver for his labor and overhead. And so we changed it and immediately he started to realize that on larger pallets, he actually could probably do better from a profit standpoint. Whereas before everything was indicating that a large pallet was unprofitable. And so after we got in, we made the change and this was about a year and a half ago, he's told me that he's had some of his best years since, as he's re re-evaluated who we prioritize from a customer standpoint and where his profits coming from. So that was a lot of fun to work on and a lot of fun to see the results come from that.
Doug:
That's a great success story. That just points to the value ultimately of what you're providing for clients. The better you help them understand their business, the better, obviously, they can do.
Andrew:
Right.
Doug:
And one of the things, I know you've always been big on this, okay, so once you go through and you understand what your costs are, it's not sort of, "Okay, now we've done it and we just leave it in place and we don't worry about it anymore." This kind of set it and forget it kind of thing. You don't want to do that. What's best practice in terms of reevaluating and looking at this?
Andrew:
Yeah, that's definitely something... Yeah. You don't want to set it and forget it because that's where we see a lot of people get into trouble because your costs may not change a lot year to year, but if you set it and forget it for 10 years, that's a significant change that could really get you in trouble pretty quick. And so normally what I recommend is if you're talking labor and overhead rates, at least reevaluate once a year. Once you have a good sense for you have good year end numbers, just at least take a look at it, update your model with your new numbers and just see once if it changed. And then for anybody who's doing tiny type of sophisticated budgeting and forecasting, that kind of thing, any time you do one of those, you can update the model again. And so I think what people will find is after they do the initial work to get everything set up, updating it on a yearly basis is not that bad of a process once you get your feet under you and everything.
Doug:
Yeah. I would imagine, like you said, all the heavy lifting is done upfront when you do it. And then to keep it updated, you're better off than ignoring it obviously, and it's not that daunting of a task. So I know one of the other things you wanted to focus on today too, are techniques for cost control a little bit. So talk to me about maybe some best practices in that regard for managing assets and things like that, that maybe we haven't touched on.
Andrew:
I think there it's just looking at and monitoring your costs on an ongoing basis. That's really the best thing you can do. And the other thing that I see a lot of people do that's helpful when it comes to that is using their labor and overhead rates to help with that. And using KPIs to know, "If my cost per labor hour is this last year, and now I see it creeping up a little bit and then figuring out why is that? Maybe it's something we can control. Maybe it's something we can't control." So using stuff like that. And then I also say too, one of the best things people can do is to mix financial data with nonfinancial data. So for instance, it sounds really, really high and high up in the sky, but really all I'm saying is take a cost and put it to an item or put it to an hour or something like that.
For instance, "What's our cost per piece? What's our cost for production hour?" So it's really just saying monitor your rates, but really when you can start to say that and say, "This piece of a chair costs this. And when we drop this pallet of raw material and it's destroyed, this is the cost," that can become some powerful metrics just to share with employees. And just letting them know, "Hey, this is the impact that happens when we get a little careless or we aren't quite as efficient on a day to day basis."
Doug:
Yeah. That's a great point you bring up, it allows the employees to be more engaged in the whole end to end process in terms of the costs and everything and understanding the impact of everything they do, which I would imagine is powerful. If I'm an employee, that's what I'd love to know. The more information, the better.
Andrew:
Yeah. Yeah. If I'm a fork truck driver and I know that I accidentally puncture whatever's on the pallet and that's $5,000, at the bottom line, that's $5,000 it's costing the company. And I think I know I would be a little more careful as I approached that.
Doug:
Yeah. That's awesome. Great information. Before we go, I know you wanted to touch maybe on National Manufacturing Day and some things we have coming up in October related to that. Can you talk a little bit about that?
Andrew:
Yeah. So the first Friday in October, I believe it's October 2nd this year, so someone can fact check me on that, it's always National Manufacturing Day. And here at Rea, we've done a little event in Berlin, Ohio, which is in the heart of Amish country here in Holmes County at the Comfort Suites hotel. And really what we do is we bring in clients, we bring in anybody who really wants to, to come in and we'll get four to five speakers in on various topics ranging from cyber security, to taxes, to HR, to investments, to costing to really you name it.
And we try to mix it up and just kind of give information and talk through issues such as this, or issues such as COVID this year. I think that's probably going to be a big theme as we plan out what the agenda is. So if anybody's interested in that, I don't know where... Obviously people are spread out across the state that are probably listening to this, but it is in Berlin so it could be a drive. But it's definitely a good way to get out and interact with people and network with other business owners and get two free meals while you're at it as well. So that's always a bonus.
Doug:
Cool. Well, hopefully I know I've attended in the past and it is a truly a great event, very informative for folks that are in the manufacturing sector and great topics. So I would encourage everybody. Hopefully we can have that in person this year, we'll see. But if not, certainly a virtual event will take place. So hopefully more on that to come.
Andrew:
Yeah.
Doug:
Well, thanks Andrew. It was great to have you on, really appreciate it. And if you want more business tips and insight, or to hear previous episodes of unsuitable, visit our podcast page at www.reacpa.com/podcast. And while you're there, sign up for exclusive content and show notes. Thanks for listening to this week show. Be sure to subscribe to unsuitable on Apple Podcasts, Google Podcasts, Spotify, or wherever you're listening to us right now, including YouTube. I'm Doug Houser, join us next week for another unsuitable interview from an industry professional.
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