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Workforce Planning in a Manufacturing Enterprise

How paying attention to workforce planning can positively impact the future financial health of the company

Those who analyze personnel expenses quickly realize how big a portion of total company expenses this can be.  This is even more so in manufacturing companies where total cost of employment can reach 50% or more of total sales and in the case of low margin companies with a high labor component in total product cost it is not uncommon for total personnel expenses to reach 70% or more of total expenses incurred by the entire organization each year.

While it is true that direct labor cost is a variable cost – it varies with production activity, increasing and decreasing the direct labor force in response to changes in product demand, while sometimes necessary, can lead to several big problems for the company if proper workforce planning is not regularly performed.  Some of these issues are:

  • A need to hire direct labor employees in a hurry which may result in inadequate screening of applicants, insufficient training and long learning curves, all contributing to higher than usual product costs.
  • Large direct labor layoffs impacting employee morale, customer and vendor confidence in the company and in the case of publicly traded companies, having potential severe fluctuations in stock prices and investor confidence.
  • Inability to find sufficient qualified candidates when unemployment rates are low.
  • High cost of training new employees when frequent layoff and rehiring cycles occur.
  • Disruption to production and inventory required to maintain acceptable customer service levels.

Companies with poor or non-existing direct workforce planning often find that their present direct labor workforce is in excess of production demand, but sometimes this imbalance manifests itself in reverse – not enough direct employees when needed, again due to poor planning which may also include flawed scheduling of work centers and machine allocations.

This usually results in companies either having to reassign direct employees to non-productive tasks if no additional inventory is needed or in the case of labor shortage, the common scenario is struggling to meet customer order delivery dates when there is insufficient inventory on hand.

These two situations have one thing in common: An adverse impact on the financial health of the company.  The following are two familiar scenarios:

Not enough customer demand:

When product demand softens, many SMB manufacturers, knowing how hard it is to rehire and train employees for the jobs that temporarily require a lower headcount, prefer to re-assign these direct labor employees to non-production activities, such as shop cleaning, inventory and material counting and reorganizing or cutting their hours as much as possible without losing them.  Sometimes excess inventory is built to utilize these extra available labor hours.  This always negatively impacts cash and increases the risk of inventory obsolescence.

The impact workforce planning has on the financial statements is, other than showing lower revenues, higher production overhead activities with lower levels of inventory produced by the same number of direct employees, causing unabsorbed costs into inventory made during that period to increase.  These costs must be capitalized per GAAP and when these products are finally sold, there is a higher charge to cost of goods sold as the result of that higher overall absorption cost.

If excess inventory is built just to keep these ‘extra employees’ busy, then several KPIs can be adversely impacted. For example, inventory turns will go down and a higher reserve for obsolescence may need to be established, resulting in an extra charge to expenses in the period the reserve was added. Other key financial ratios may also suffer, thus decreasing the overall financial health of the organization.  This can be temporary or extend over many accounting periods.

Cannot keep up with customer demand:

In this scenario an unanticipated or poorly planned rise in customer demand with increasingly harder to meet delivery dates for many customer orders is commonplace in SMB manufacturers.  Since this often occurs as a surprise, scrambling to hire and not knowing how many employees to hire for the various direct labor positions (again due to lack of or poor personnel planning) creates a lot of stress on management and the existing employees.

One common solution is increasing overtime.  I’ve seen overtime to regular time ratios in excess of 30%.  At 150% the regular hourly rates, plus additional payroll taxes and other payroll related expenses, this can significantly increase the unabsorbed costs into inventory made in an accounting period.  As in the not enough product demand scenario above, this means that these unabsorbed costs must be capitalized into inventory which makes subsequent product costs higher when these products are sold.

Just like forecasting the proper level of inventory through careful and insightful revenue planning and use of state of the art FP&A software solutions, having the right number of direct labor employees with proper skills in the various manufacturing areas is paramount to achieving growth and profitability.

The best of these FP&A solutions have a dedicated personnel module where required employees can be planned one at a time or in groups of employees serving the same function.  Through use of drivers, these direct labor positions can be automatically placed in the plan (i.e., number of direct employees needed in each of the budget periods, at the planned hourly rates, etc.).  Then, linking predefined payroll related expenses (e.g., Social Security, Medicare, health benefits, etc.), overall personnel expense can be automatically forecasted in the software.

Consequently, using analytics functions, impact to financial statements as a result of personnel planning can be clearly seen and analyzed.  Having synchronized financial statements, a complete and accurate analysis of the future financial health of the company can be performed. Check out my two blogs on the topic: All About Synchronized Financial Statements Part 1 and Part 2.

Personnel expense is a large expense in every business, and particularly in manufacturing enterprises.  Using a sensible approach to workforce planning, along with an FP&A software solution with a built-in personnel module can make a big difference in the overall performance of the company.  This will be clearly reflected in both actual and forecasted financial statements.

Alan Hart, MBA, is Principal Consultant at Pacific Shine Group in Portland, Oregon, with responsibility for client business development and hands-on client project implementations. Prior to starting Pacific Shine Group, he worked in various executive accounting and finance positions with technology and growth companies. Notable is his 18 years in the hi-tech manufacturing industry where he served as Controller, Vice President of Finance and CFO of several privately as well as publicly held companies in the Hi-Tech industry, such as Hybrid Arts, Inc., Hamilton Bay Associates and Syncronys Software.  In his role in management consulting, Alan has worked in diverse industries and with a variety of clients, including fortune 1000 companies such as Boeing, Delta Airlines, Intel, Wyndham Worldwide and others, as well as many mid-market organizations such as Guitar Center, Ducommun AeroStructures, Cypress Semiconductor, TriQuint Semiconductor and others.

Combining his skills and experience in engineering with deep understanding of technical accounting, he is able to assist small and medium-size manufacturing companies establish GAAP compliant accounting and reporting systems.

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