Having worked with a significant number of manufacturing, consumer and industrial products and food processing clients over the years, particularly in the middle-market arena, I have identified five key areas that can be better managed and improved to increase business performance and profitability. Participants in the lower middle-market, and larger small businesses, typically reach a threshold where many of these issues, if not properly managed, can significantly reduce profitability and performance.

Additionally, when revenue is increasing, management is less cost sensitive. Further when growth occurs at a fast rate over a short period, inefficiencies can develop and margins can sometimes drop. Following these guidelines can help middle market manufacturers capture more profits and continue sustainable growth.

1. Capturing and tracking all inventory costs at the point of conversion

Inventory in a manufacturing and food processing environment is more than just material costs, it also consists of labor, overhead costs, and storage in many cases. Accurately and effectively capturing all these costs and assigning them to the proper job or product is imperative if an organization wants to accurately account for their inventory assets and cost of goods sold. Properly collecting these costs requires effective processes and a system of internal controls. Correcting this deficiency will improve reporting and lead to better pricing decisions and reduce significant inventory adjustments that affect your cost of goods sold at the end of the fiscal year.

For example, not too long ago I worked with a lighting manufacturer who built specialty, custom lighting products for commercial applications. They lacked formally defined processes for requisitioning parts inventory when building and assembling their finished lighting products. Additionally, they didn’t have a system to effectively capture the usage of the inventoried parts, so much of the usage didn’t make it to the specific job within the accounting system. This allowed for inaccurate part inventory amounts and values that resulted in significant cost of goods sold adjustments at year end. Further, the assembly labor costs were not accurately tracked to the job when the work was being performed. Effectively, jobs that required more labor than was estimated at the time of the Sales Order or quote, were not being tracked and assigned on a direct cost basis.

This may seem like an exaggerated case, but it highlights the importance for structuring and designing a system that captures and tracks labor and inventory usage at the point of conversion. Deficiencies in this area lead to poor pricing decisions, inaccurate inventory and period end adjustments that will routinely reduce financial statement performance.

2. Rework and warranty claims

This is an area that is normally overlooked when costs are not significant. However, rework and warranty claims can easily become significant in a short period of time if the manufacturing process does not have a well-managed and effective Quality Control process that identifies and remediates deficiencies with continuous feedback.

I worked with a technology accessory manufacturer that used a contract manufacturer in Asia to manufacturer their product. Product quality became an issue for the main customer, which was a well-known accessory brand and a recall was eventually required. This significantly impacted the company and their financial position to a point of near catastrophe.

Another example involved an apparel company. They didn’t have a defined process to account for returned and replaced garments Although this was not a major crisis, it did impact their inventory tracking and their financial performance. If management invests early in the product development and quality monitoring cycle, needless costs can be avoided and customer happiness will be increased. Two things all manufacturers can appreciate.

3. Inefficient and excessive use of energy

Energy usage and consumption can be a huge cost driver for many manufacturers. In fact, manufacturers consume more than 30 percent of the nation’s energy. U.S. industrial users consumed 26 quadrillion btu of energy in 2018 and that amount is expected to grow at 31% to 34 quadrillion btu by 2050.

For smaller, mid-market companies, energy management does not always get the attention it deserves. But management programs and improvements can produce real cost savings that can really improve profitability. Lighting, heating and cooling, proper insulation, machine idling, and leaky boiler pipes are just a few examples that can seriously contribute to energy waste, which impacts the bottom line of many businesses. Heating and cooling large facilities alone are a significant cost.

For example, converting from a 34 watt fluorescent tube to an equivalent 16 watt LED tube would save approximately $26 per bulb if operated 24/7 for one year. Take a space that has 200 bulbs and you have an annual savings of $2,600 is operated 12 hours a day or $5,200 if operated 24 hours a day. Grants in some states, such as Maryland are available to manufacturers to improve energy utilization. This is a win-win for manufacturers and the state, as most buyers avoid improvements due to the immediate cost outlay. Consider an energy audit and put a program in place to improve the use of energy consumption throughout your plant, warehouse or office facility.

4. Material waste and theft

It is still surprising to me when I do a walkthrough of a plant and a production line and see significant waste. Waste minimization is a mindset and needs a system of controls to reduce it and ultimately prevent it. In the food processing industry, this can be compounded as once material hits the floor, it cannot be reprocessed/reworked for human consumption. I take the view that anything less than 100% of the raw material converted to the finished product is less than optimal and a loss to the organization.

For example, I once visited a seafood processing plant that produced fish nuggets and patties for commercial and institutional consumption. The fish came into the plant in a partially processed frozen block form (already scaled and deboned). These fish blocks needed to be portioned and breaded. In processing the roughly 20 pound blocks into filets, strips or nuggets, the blocks were cut with a food grade band saw. This process produced a significant amount of “fish dust” or scrap product, just a cutting a piece of wood would produces saw dust. The amount of “fish dust” was at times in excess of 8% of the weight of the fish block. This was astounding as the scrap that was produced had limited usage and value per pound. What was even more astounding was that one of the owners didn’t know how much scrap was being produced from each block.

In my mind, this was a lean Six Sigma project as the amount of waste was unacceptable and very costly. The bottom line is: know your yields and invest in limiting waste and safeguarding your raw material now to save money over the months and years ahead.

5. Ineffective financial reporting

A financial reporting function should provide your organization with accurate, timely and usable information for decision making, in addition to fulfilling compliance requirements. Information that is poorly collected and processed is not reliable, no matter how experienced your management team. Many small organizations don’t fully understand and quantify missed opportunity cost. Obviously, any new software implementation is a cash outlay, but the future savings should be quantified and measured though a net present value calculation.

The old adage “time is money” is certainly true here. An effective financial reporting system, which includes a properly implemented software product, trained users and a system of controls can provide significant value. Not only can your historical performance be measured, your organization can track and improve margins and yields when the manufacturing data is produced in a timely fashion and accurately collected. Not having an effective financial reporting function can be a road block or hurdle for bank and investor financing. If the organization does not have a perpetual inventory system, doesn’t know its gross margin by product/sku, or doesn’t have the ability to allocate and separate costs per products effectively, then improvement and remediation is needed.

If your net present value is positive, then spend the time and invest the money today to properly implement a financial reporting system that addresses your specific needs and can collect information at all the important control points. Don’t let GIGO (garbage in, garbage out) be your financial reporting function’s motto!

Addressing one or more of these areas can have a dramatic impact on your manufacturing firm’s profitability. In many cases, your organization can begin with a relatively simple assessment by an outside professional or internal resource. However, make sure to get the right professional with expertise in that area to assist your organization so you can make the most of the effort and maximize your cost savings or value add.

Many cheered the passage of the 2018 Farm Bill, which descheduled industrial hemp and its derivatives (including CBD). But that was just the start of a much more complicated regulatory story that continues to have a major impact on entrepreneurs, investors, and advocates and patients who rely on CBD.

CBD and the 2018 Farm Bill

When President Trump signed the 2018 Farm Bill into law one of the key changes affecting the cannabis industry was the separation of “hemp” and “marijuana.” Before the Farm Bill, any incarnation of the cannabis plant and its byproducts were lumped into a single category and considered a Schedule 1 drug. Key language in Section 1103 of the Farm Bill defines hemp as:

“the plant Cannabis sativa L. and any part of that plant, including the seeds thereof and all derivatives, extracts, cannabinoids, isomers, acids, salts, and salts of isomers, whether growing or not with a delta-9 tetrahydrocannabinol concentration of not more than 0.3 percent on a dry weight basis.”

In short, the Farm Bill descheduled industrial hemp and its byproducts as long as it stayed under the threshold of less than 0.3 percent THC. CBD is derived from the cannabis plant, whether there are significant levels of THC or not. CBD industry advocates have interpreted the language “all derivatives, extracts, cannabinoids, isomers, acids, salts, and salts of isomers” as descheduling CBD when industrial hemp is the source. And they are “mostly” correct in this interpretation. Unfortunately, there are other federal agencies in play.

CBD and the FDA

United States Department of Agriculture (USDA)  enacted the 2018 Farm Bill in their position overseeing laws related to the cultivation of industrial hemp. The United States Food and Drug Administration (FDA) oversees medicine and food additives. CBD has emerged as a “wonder drug” with a growing list of potential benefits and now appears as an additive in a wide range of consumer products. In addition, the FDA approved Epidiolex, the first CBD-derived drug, in 2018.

All of this has culminated in CBD being a priority of the FDA, so much so, that just a week after the Farm Bill was signed into law, the FDA issued a press release clarifying and asserting their regulatory control over all cannabis-derived compounds.

“We treat products containing cannabis or cannabis-derived compounds as we do any other FDA-regulated products — meaning they’re subject to the same authorities and requirements as FDA-regulated products containing any other substance. This is true regardless of the source of the substance, including whether the substance is derived from a plant that is classified as hemp under the Agriculture Improvement Act.”

Concurrent with the Farm Bill and the press release regarding CBD, the FDA also issued three Generally Regarded as Safe (GRAS) notices for hemp by-products: hulled hemp seeds, hemp protein powder, and hemp seed oil. Clearly demonstrating that (some) hemp products have been descheduled and cleared for use by the FDA.

The FDA’s policy is different toward CBD for two key reasons. Firstly, CBD products are largely marketed with a wide variety of therapeutic claims. In their press release the FDA notes:

“The FDA requires a cannabis product (hemp-derived or otherwise) that is marketed with a claim of therapeutic benefit, or with any other disease claim, to be approved by the FDA for its intended use before it may be introduced into interstate commerce.”

Secondly, the FDA’s approval of CBD-based drug Epidiolex, put CBD and THC into the category of “active ingredients in FDA-approved drugs.” Under the Federal Food, Drug, and Cosmetic Act (FD&C Act) it is “illegal to introduce drug ingredients like these into the food supply, or to market them as dietary supplements.”

In short, the FDA does not distinguish between CBD derived from hemp or “marijuana,” and until the agency approves CBD and establishes a regulatory framework, adding CBD to food and beverages is illegal.

Has the regulation of CBD slowed businesses?

While early CBD research has shown promise as a treatment for conditions like epilepsy and anxiety, as a consumer product it is unproven and has been largely unregulated until recently. In the absence of labeling standards and regulated dosage guidelines, consumers often have little understanding of what they are buying and its potential effects.

All of this uncertainty has earned greater regulatory attention for CBD. There have been reports of crackdowns on bakeries, restaurants and retailers selling CBD in California, New York, Maine and Ohio, just to name a few. This regulatory response has shocked and angered a number of hemp producers and CBD retailers who have invested millions into business ventures that they feel only supply the public with products that help manage health concerns.

Despite the confusing legality, the CBD industry appears to be moving full-steam ahead. In recent months, national retailers as diverse as Walgreens, DSW and Barney’s New York have announced plans (or have already begun) selling CBD products. Indicating the burgeoning CBD industry is well on the way to mainstream acceptance.

What is next for CBD?

In February, former FDA Commissioner Scott Pruitt testified before the House Appropriations Committee and said that the FDA is initiating a rule making procedure with the goal of creating “an appropriately efficient and predictable regulatory framework for regulating CBD products.” The FDA will launch the process with a public hearing on CBD scheduled for May 31, 2019.

Further complexity struck when Pruitt unexpectedly announced his  resignation, which took effect in early April. Pruitt has been replaced by Dr. Ned Sharpless, the former director of the National Cancer Institute. To date, it is unknown whether Sharpless intends to take a progressive stance toward CBD.

While delays occur at the federal level, states are shifting into action. Maine recently passed an emergency law governing CBD. The bill aligns the definition of hemp in Maine’s laws with the definition used in the Farm Bill. Meaning, as long as CBD is derived from hemp sources it is to be considered a food product, rather than medicine, and is cleared for use in Maine.

Ultimately, until the FDA creates a regulatory framework for CBD, it will remain illegal to add it to any food or drink products.

Learn more about the FDA Public Hearing on CBD here

Provide a public comment for the FDA on CBD here