Industry: Paper Products Manufacturing

SUMMARY OF PROFIT MAXIMIZATION CASE I

Paper Products Manufacturing – Phase I

Challenges:

Corrugated Sheet and Box company with $35 million of annual sales company had an annual net loss of ($500,000). Systemic financial control weaknesses were possible. An external audit disclosed a material misstatement of earnings, assets and liabilities. Cash flow was negative. Production flow was less than optimal. Information systems were antiquated.

Approach:

Stabilize financial reporting; assure bank auditors that financial controls were adequate.
Institutionalize controls for accounts receivable and inventory and train personnel.
Optimize production scheduling. Implement formal machine maintenance programs.
Begin conversion of all financial and operational information systems.

Results:

Profitability achieved within 8 months. Net annual income for the year after profitability was achieved totaled $1,200,000.
Aged accounts receivable 90+ days old was reduced from 14.8% to 2.5% of total AR. Tainted receivables was reduced by $1,500,000.
Finished good inventory reduced 30%. Raw materials inventory reduced by 50%.
Cash flow improved and borrowing requirements decreased. Overall business risks decreased.
Order expediting became an exception rather than the rule. Direct labor costs dropped 20% on a $/unit basis.

DETAILS OF PROFIT MAXIMIZATION CASE I

Industry: Paper Products Manufacturing – Phase I

The Company:

MP Co. was initially a $35 Million Corrugated Sheet and Box manufacturer with 2 supplemental warehouse locations. This plant had several owners prior to its acquisition. Throughout it’s history, it had never been profitable. The goal was to make this initial plant profitable.

The Challenges:

Accounting:

Although the primary manufacturing location had not been profitable prior to my arrival, the owners thought they had finally turned the company around and were profitable. However to their surprise, a year-end audit disclosed that rather than having made a $500,000 profit, they had incurred a $500,000 loss instead. Bank covenant agreements had been broken and the bank auditors had already scheduled a visit.

Due to serious health issues, the previous controller was not able to keep up with the workload. Financial statements were being produced 2 months late. A desk drawer held tens of thousands of dollars of prepared but un-mailed checks. Most liabilities were either unrecognized or under-reported. Assets were undervalued for rebates receivables, scrap sales receivables and various prepaid expenses. Fixed asset accounting was incomplete.

Billing, Credit, Collections and Accounts Receivable:

The billing process had a 3-day lag built in to mitigate customer complaints and delivery issues. After the issues had been identified and the billing corrected, only then would an invoice be printed and delivered to the customer. This was achieved through manual paper record keeping. A detailed review disclosed that this resulted in some items never being invoiced.

There was no formal credit approval process or collections process. The office manager routinely wrote off $15,000 a month of short pays to cash discounts without any authorization. Despite this, the accounts receivable aging and days sales outstanding were worrisome. Credit limits had not been established and collection calls had never been done. More than $2.0 Million of receivables was considered “tainted” by the banks and was not eligible to be included in the borrowing base.

Inventory:

Inventory turns were low and days of sales on hand was high. Raw materials inventory had crept up to high levels. Approximately 20% of the finished goods inventory was aged and un-sellable. Reserves for aged inventory did not exist.

Customer Service & Sales:

Customer service had many challenges. Product quality and late deliveries necessitated that customer service spend most of its time expediting orders through the plant or buying them from other vendors just to satisfy the customers. The customer service manager took great pride in being able to expedite orders and satisfy the most demanding customers.

Information Systems:

An antiquated financial and operations system was being used. No one knew how to set up the costing or other criteria within the system. Although no one was sure how it was set up or worked, it was used to prepare customer pricing and inventory valuations for finished goods and raw materials.

Maintenance:

There were no formal preventative or predictive maintenance programs. A training program was not in place. Spending on parts and labor was excessive. Downtime was also problematic.

Manufacturing scheduling:

Manufacturing scheduling had been instructed on “lean” principles. However the process that had been implemented needed optimization to reduce downtime and improve plant throughput.

Human Resources and Accounting Personnel:

Safety, payroll deduction, tax, garnishment and retirement documentation was not up to normal standards. More than $7,000 of monthly payroll deductions was going uncollected. Formalized safety programs were not practiced. Workers compensation expense was high. And many of the office personnel lacked the basic computer skills required to effectively perform their duties.

Housekeeping:

Idled machines, obsolete parts and cutting / printing dies of former customers were kept in many areas of the plant. Expenditures for building maintenance and cleaning were kept at a minimum. Locker rooms were in need of renovation.

Approach:

Bank Relations and Financial Reporting:

The company was in a state of shock. Confidence in financial reporting had to be restored quickly.

Stabilized the accounting and prepared meaningful financial statements through the current period.
Met with bank auditors and ensured financial control was adequate.
Accounting controls for accounts payable and liabilities were implemented. Implemented a plan to recognize all accrued expenses and reasonable reserves before the year-end audit.
Accounting for assets was reconciled and updated as soon as possible.

Billing:

Because of the persistent quality and shipping quantity errors, the billing process had been set up to correct for errors before invoices were generated. This eliminated the incentive to correct errors and caused some shipments to go unbilled.

Changed all billing processes. Sped up billing to ensure that customer billing occurred the same day as shipments.
Changed processes to ensure that all credits, returns and allowances would be recognized internally so that corrective actions could be implemented. Causes of credits were traced to specific personnel.
Sales personnel were tasked with helping to resolve customer short pays and credit requests.

Accounts Receivable, Collections and Credit:

Accounts receivable was the largest asset, yet no one was responsible for its management. Since credit limits, compliance with terms and collection calls were new to this company, considerable care had to be exercised with both customers and salespersons.

Assigned a full time person to manage accounts receivable, collections and credit.
Developed collection program and bonus awards for collection of accounts receivable. Reduced tainted receivables by 79% and greater than 90 day old receivables by 60% within 4 months. Total DSO was reduced by 20 days.
Implemented credit terms and level approval process that included D&B analysis and approval by finance, sales and the general manager.

Inventory:

Finished Goods:

Customer service had the authority to determine items to keep in finished inventory.

Since on time deliveries were a constant problem, finished goods inventory was maintained at excessive levels. Later, customers were either lost or their product requirements changed. However, there was no process for handling their inventory.

Implemented inventory authorization process. Only approved inventory items could be produced for inventory.
Inventory maximums, reorder point and reorder quantities were determined and coded into information systems to ensure compliance.
Warehouse agreements and customer purchase orders were executed to ensure that customers would pay for old inventory.
Identified aged and obsolete inventory. Implemented time specific salesperson / customer incentive program to reduce slow moving and obsolete inventory.
Sold remaining obsolete inventory as scrap.

Raw materials:

Production scheduling had the authority to determine the levels of raw materials to keep on hand. Customer specific raw materials had been ordered and not used. No formal forecasts of sales or purchasing were done. Thus, raw materials inventory was excessive and some was aged.

Supplier lead times were documented. Minimums, maximums and reorder points were implemented.
Monthly Sales budgets and forecasts were married to purchasing activities.
For customer specific raw materials (preprint roll stock), customer purchase orders were executed to ensure that customers would buy unused materials.

Production Scheduling:

The plant consisted of two primary areas the corrugator and converting. The corrugator made corrugated sheets that where used in the converting department and sold to other converting companies to be made into higher margin boxes. The production manager had been instructed to follow single piece flow and keep work in process inventory to a minimum. The result was constant swings from an empty converting department to an overflowing plant. {See also diagram 1}

Formal production schedule program was developed and implemented.
WIP inventory increased.
Run and Ship philosophy was launched.

IT System Conversions and Cost Accounting:

Across the entire organization the IT systems were severely outdated and ineffective. Although no one knew how the cost models were developed or how to change them within the IT systems, they were used to produce customer pricing and inventory valuations. Financial reporting to the corporate office was done via spreadsheets.

The Accounts Receivable, Accounts Payable, General Ledger and Financial Reporting systems were converted to Great Plains and FRx reporting.
All customer service, production scheduling, costing, and inventory management systems were converted to Amtech.
Costing models were developed for every machine center.
Finished goods and raw materials inventory valuations were increased as a result of updated costing models.

Maintenance:

The maintenance department did not have formal preventive and predicative maintenance programs in place. It was constantly working in crisis mode and incurred substantial overtime. There was no on going training to increase their skill levels. There was a level of animosity between maintenance and the production departments.

Implemented formal work order system.
Tracked work orders by machine center and complaint codes.
Instituted weekly maintenance meeting where managers and supervisors from both production and maintenance would meet to review open, closed and recurring work orders.
Continuing professional education was instituted for all maintenance personnel.

Human Resources and Accounting Personnel:

The skill levels of the accounting and HR personnel were inadequate.

Two people were hired and two other people were recruited from other parts of the plant to work in purchasing and IT support.
Comprehensive training programs were instituted for each functional area.

Customer Base / Profitability / Service Requirements:

A customer analysis was conducted to get a better understanding of the customer base. Customers were categorized by purchased volumes, pricing levels, timeliness of payments, returns and credits, and emergency orders that required special shipments.

Analysis of the customer base showed that 80% of sales came from the top 113 customers. The remaining 237 customers provided the remaining 20% of sales. Generally, the customers that fell into the low price, low volume category also had the greatest number of credits, the majority of the special rush orders, they paid the slowest and requested we carry inventory of their items.

Shipping costs, customer service, design costs, and credits for returns and allowances were disproportionably high for the Low Price / Low Volume (LP/LV) customers. In addition, the related carrying costs of their inventory and accounts receivable was high.

Success implementing changes was muted in Phase I. The idea was to reduce the number of LP/LV customers and their related activities. Then headcount in design, customer service and shipping could be reduced, further increasing profitability. This area was more successful during Phase II.

Housekeeping:

Previous management had resisted scraping many outdated pieces of machinery and printing / cutting dies. Inoperable trailers were used for storage for obsolete equipment and parts. Plant lighting, cleanliness and lighting needed to be improved.

Eliminated all storage trailers, and sold obsolete equipment as scrap steel.
Improved lighting and cleaned and painted.
Hired a professional cleaning/sanitation company.

Results:

Profitability:

Despite having never shown an annual profit, and the need to build up significant accrued expenses for financial reporting purposes, profitably was achieved 8 months after my start.

Previously, the company results ranged between break-even to losses of approximately $80,000 per month. In the previous year, it had lost $500,000.

During the full year following implementation of changes, the net plant income was approximately $1,200,000. With the best month showing a profit in excess of $200,000 and only one month showed a small loss.

Accounting:

Financial reporting was routinely completed within 3 days after the end of the month versus two months late.
Several audits were conducted by the company’s lenders and public accountants. No issues were ever reported. Thus, there was much greater confidence in the financial statements and management’s statements concerning the operations.
Bank agreements were renegotiated with more favorable rates and covenants.

Billing and Quality:

Billing occurred 3 days earlier. As cash receipts started to come in faster, borrowing requirements decreased by almost 3 days of sales or $435,000.
Credits were tracked and corrective actions initiated. As a result, many new procedures concerning new products and customers were implemented that addressed the root causes of the credits.
Accountability was driven to the lowest level whenever possible. For example, material handling personnel had individual stamps that identified who loaded each bill of lading

Accounts Receivable

Aging significantly reduced. Within 6 months the greater than 90 days old was reduced from 14.8% of total AR to 2.5%.
Tainted receivables (90+ days > 20% of total balance) was reduced by approximately $2,000,000.
These actions increased the borrowing base from which the company could draw funds for operations and capital expenditures.

Inventory:

Finished goods inventory was reduced 30% . Days sales on hand was reduced from 16 days to 8 days.
Slow moving inventory was reduced from 20% of finished goods inventory to approximately 6% of total inventory value.
Raw materials inventory was reduced by approximately 50%. The best month was a roll stock inventory level of $875,000 versus a typical inventory level of $2.2 Million.
Cash flow was improved and borrowing requirements decreased. Accounts payable and days payable outstanding decreased from more than 180 days to less than 90 days. Thus overall business risk was reduced.

Customer Service and Production scheduling:

Expediting Hot orders became a thing of the past. Late deliveries were infrequent. After a period of adjustment, the customer service manager started to focus on other areas needing attention.
Direct labor costs dropped 20% on a $/MSF basis.
Truck, trailer and driver utilization improved. Delivery costs stayed stable despite rising energy costs.
Overall productivity and sales throughput increased by 40%, increasing profitability.

Maintenance:

Initially, maintenance costs increased substantially. Then after a number of ongoing issues were corrected, and new preventative / predictive maintenance programs took hold, expenditures dramatically declined.

Maintenance overtime and expenditures on repair parts were both cut by 25%.
Maintenance personnel completed several computerized diagnostic training classes. Some were eventually lost to other companies. But overall efficiency in the department increased.

Human Resources and Accounting Personnel:

All areas were upgraded.

Previously outsourced IT and Payroll processing activities were brought back in house further reducing costs.
Payroll deductions occurred properly so that all employees were paying their correct share of healthcare, taxes, child support and other garnishments. This added approximately $84,000 to the annual net income.

Moral:

A halo effect from high profitability, brighter and cleaner facilities and smoother running operations was achieved. The attitude at the plant changed from a state of shock to one of confidence and high expectations.

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