Mastering fabrication by mastering cash management

Even in a competitive market, fabricators are increasing their profits.

According to the late Dick Kallage, an industry consultant and former columnist for this magazine, many fabricators fail not because of a drop in sales from a recession, but because they run out of cash trying to meet customer demand during the subsequent rebound. Shop owners I’ve talked to over the years have agreed. Mastering custom fabrication is about mastering cash management.

The best among them have certainly accomplished this, and many of these shops evidently participated in the “2017 Financial Ratios & Operational Benchmarking Survey.” An annual publication from the Fabricators & Manufacturers Association, the survey has evolved to become an industry report card of sorts. The study does have a small sample of about 50 shops, but the study goes deep into the fabricator balance sheet, offering a peek into what is by and large an industry of small, privately held companies. This year’s study covers shops’ 2016 fiscal year.

This is of course a capital-intensive business, and average debt ratios (total debt divided by total assets) did increase, going from 0.33 in 2015 to 0.41 in 2016, hence the importance of cash management. But even this ratio isn’t off the charts.

Survey respondents have stellar liquidity situations. The average current ratio (assets divided by liabilities) is 4.9, and the average quick ratio (same thing but with inventory taken out) is greater than 2.6.

Perhaps most impressive is that even as sales fell (shrinking in 2016 by an average of 3.6 percent), average profits grew slightly from fiscal 2015. Earnings before interest, taxes, depreciation, and amortization (EBITDA) margins grew slightly from fiscal 2015, from 8.4 to 8.6 percent, and average operating profit grew more than a percentage point, from 5 to 6.2 percent. Gross margins jumped by even more, from 26 to 29 percent. About 36 percent of respondents said their EBITDA margin is 10 percent or greater. “A generic target of 10 percent works for most fabricators,” wrote Steve Zerio, CFO of Form Tech Concrete Forms, in the study’s commentary.

Note that these are all averages, and the range for some metrics is rather wide. Most fabricators are small companies, and many also have high revenue concentrations. On average, respondents said that half of their company revenue came from four customers, while 80 percent of revenue came from 12 customers. If a small shop has very high revenue concentration, losing just one major customer can be catastrophic, and their balance sheets can look starkly different from seemingly similar fabricators who happened to not lose a major customer.

It’s a common conundrum, even among the most successful, high-quality operations. Many ensure no one customer makes up a certain percentage of revenue. But if a fabricator proves it can meet a large customer’s demand, and that same customer then sends more work, a fabricator isn’t about to turn it down.

After all, sales growth is a valuable thing. It’s what makes operational and technological improvements financially viable. The improved process opens capacity that can be filled with additional sales.

It’s been a roller coaster ride for the sales growth metric over the past few years. 2014 was the high point, with survey respondents averaging 7.1 percent sales growth. 2015 sales growth dropped to 3.9 percent before contracting in 2016—though again, results varied from shop to shop.

The sales contraction in 2016 perhaps affected the slightly lower sales per employee (averaging $160,000, down from $163,000) and lower value-added per payroll dollar, at 2.09, down from 2.17 in 2015. Value-added per payroll dollar is calculated by subtracting material costs from total sales, and then dividing by total payroll expenses. It shows how much you get out of every payroll dollar you spend. So, on average, metal fabricators get $2 back for every dollar they spend on people.

To increase sales, a fabricator can offer better service, faster response, a lower price, or a combination thereof. And herein lies another challenge of custom fabrication: on-time delivery. Average on-time delivery improved 2 percentage points, to 88 percent. The average has been between 85 and 88 percent for the past several years.

Although this is only anecdotal, for years I’ve heard shop owners tell me that customer lead-time demands are becoming ever more stringent, so quick that they need to keep some finished goods. Some contract shops may build ahead in an attempt to level-load the schedule, particularly if they serve seasonal customers. Some operations hold and replenish large finished-goods inventories for certain customers.

This is where job velocity comes into play again. Average inventory turns (the cost of goods sold divided by the average dollar amount of inventory) are on the rise. The average is up a turn in 2016, to 9.1—though again, the range varies widely among respondents. Fifteen percent said they had between 14 and 20 inventory turns. Inventory turns aren’t an exact measure of job velocity, particularly in custom fabrication operations that carry a healthy raw stock inventory, but it does give an indirect hint.

If material turns over frequently, it’s probably moving faster through cutting, bending, welding, and beyond. And that’s a good thing, considering material is one of the greatest costs a fabricator has on the books. Though in fiscal 2016 material was a little cheaper, at 32 percent of sales on average, down 2 percentage points from the previous year.

Regardless, better inventory turns boost cash flow. And if it’s good for cash flow, it’s good for the metal fabrication business.

For a complete copy of the “2017 Financial Ratios & Operational Benchmarking Survey,” visit www.fmanet.org/store and type the survey title into the search bar.