Voiceover:
From Carr, Riggs & Ingram, this is It Figures, The CRI Podcast, an accounting, advisory, and industry focused podcast for business and organization leaders, entrepreneurs, and anyone who is looking to go beyond the status quo.
Sam Clark:
Welcome, everyone. Manufacturing leaders are under more pressure than they’ve been in years. Margins are tight, inventory is more complex, the workforce is stretched, and there’s constant noise around tariffs, taxes, and technology. Today, we’re going to cut through that and talk about what’s really impacting performance and decision-making. I’m Sam Clark. I’m a CPA, and I’ll be moderating today’s conversation.
I’m joined by Chad Sexton, also a CPA, who works closely with manufacturing companies about both financial and operational challenges. This will be a practical discussion grounded in what we are actually seeing with clients. So Chad, let’s start at a high level. When you look across manufacturing companies right now, where do you see the biggest disconnect between reported financial results and what’s actually happening in business?
Chad Sexton:
Yeah, thank you, Sam. I do appreciate you doing this today. This is a good topic. You mentioned I work closely with manufacturing companies. I’m going to talk today from two different perspectives. I’m an auditor, so I do a lot of financial statement audits for manufacturing companies, but then also I do a lot of consulting with business owners, and so they’re asking a lot of these questions.
These are some of the topics that come up on a day-to-day basis from either an audit standpoint or discussions with owners. One of the biggest disconnects that I see is really understanding the financial statements, truly getting in there and understanding. A lot of business owners will have a CFO to handle most of that, but sometimes business owners don’t go the step further and really understand what their financial statements are telling them.
The other side, those that do have good financial statements, monthly financials, good close process, they may understand the financials, but don’t really take it a step further and look at the why behind it, ask the why questions. Why are we seeing certain trends? The trends are a big one that we like to look at from audits, an audit standpoint, but also good for business owners to take that step too and look at maybe gross profits.
Maybe they’ve seen a dip in gross profits over time. They may be looking at it. Well, I tend to see it between, I don’t know, 30, 35%, just throwing numbers out here. But if it’s continually declining year after year, you would want to get an idea of what’s causing that. So those are the two main areas, just disconnect between what’s really happening in a business and those financials.
Sam Clark:
So what does that usually show at first, like revenue recognition, accounts receivable, inventory?
Chad Sexton:
Yeah, those are the three main areas. Anytime I’m talking about manufacturing companies, inventory’s going to be a big topic. Most of the time it’s the biggest asset on the books. If not the biggest, one of the biggest assets in a company. And so when we look at inventory, we’re looking at really two components, the quantity and the cost. The quantity is pretty self-explanatory.
How much inventory do we have out there? Businesses will implement accounting policy where they go out and count inventory either on a monthly or quarterly, sometimes longer than that, to make sure that they have the quantities actually physically out there and those agree to what’s in the system. You can get sideways with that if you’re not doing periodic counts.
If your system’s saying, “I’ve got 10 items of this product,” and you really only have five, well, if you go get a purchase order for seven of those, you’re going to come up short. So it’s always a good idea to have good count policies out there. The other component is the cost side. So for manufacturing companies, you have the cost of the raw material itself, but then you’ve also got to add the cost for the manufacturing process itself, so labor, overhead, those type costs.
And really getting a good understanding of what true costs are in your finished goods inventory once it’s all produced, ready for sale. Sometimes businesses will get messed up in not being able to identify the actual cost that should be included in there. So that’s an area that we tend to look at pretty heavily. The other piece, once you have all those in place, you’ve got good quantities, you’ve got good cost in place, we also look at if there’s any excess inventory.
So years ago when COVID hit, a lot of manufacturing companies were buying as much product as they could. Supply chains were disrupted. And so they may have excess inventory on hand that either is not going to get sold or maybe outdated. From an audit standpoint, we look at that for potential impairments of inventory or may need to write it down. But from a business side, a lot of your working capital can get taken up in inventory that you’re not going to be able to sell or not be able to sell at what you thought you were going to sell it.
Well, you may have to reduce the price. So that’s another area that you would… From a business owner standpoint, you would want to monitor that, manage how much inventory that you had in place. The numbers may be good, but the product itself may not be something that’s sellable or usable. You mentioned two other areas, revenue recognition. We always look at revenue recognition.
It’s always a risk in an audit. So business owners should be aware of that. From a manufacturing standpoint, most of the time we see a sales process as you get a purchase order in, you fulfill that order, and then you sell it, and recognize revenue at a point in time when that shipment’s made. Sometimes when that can get a little more confusing is when you’ve got multiple deliverables or multiple performance obligations, we call it.
You may have to break up that sales price a bit. Other complications is when you have a return policy. You may sell an item, but if you have a return policy, you have to estimate what may be coming back. And then also another big one is like a bill and hold type agreement where you may have a sale to a customer, may get close to the end of the year. They want to go ahead and order a product.
You’re going to bill for it, and then hold it until they pick it up. I actually ran into a situation years ago with a company where they had a bill and hold transaction right at the end of the year. I was actually counting the inventory. And then later on, several weeks later when we came back to do the audit, that inventory was still there. So wasn’t truly a sale, so it uncovered several things that we had to deal with.
But any kind of bill and hold transaction, you would want to look at that to make sure that it truly does qualify for a sale. Going along with that, your accounts receivable, the big thing on that is really monitoring and managing the AR aging. We always look at the buckets of AR, whether it’s 30 days, 60, 90 days old. But from an owner standpoint internally, you should be monitoring that as well. Obviously, you don’t want those receivables to age too long.
If you’ve got a lot in a 90-day or over 120-day bucket, then that could be an indication of a problem, and so having someone manage that and really investigate any declining trends. If you’re typically have 90% of your AR under 60 days, but you’re starting to see where that’s extending out, it could be an indication that a customer’s having financial difficulties or there could be an issue with ultimately just collecting your receivables. So monitoring that is a big item as well.
Sam Clark:
Yeah. So in our world, financial reporting obviously is keen, and obviously management provides us with estimates like inventory reserves, AR reserves, et cetera. So in your opinion, Chad, with estimates that are involved with labor overhead, bonus accruals, inventory reserves, AR reserves, where do they tend to get stretched in your opinion?
Chad Sexton:
Yeah, and a lot of times those… Well, you mentioned some of the big ones, your AR reserve, inventory reserves, the labor and overhead, application, capitalizing the labor and overhead. Those are some of the main ones. Where they get stretched is where… Two things come to mind really. If a company’s not doing so well a certain year, they may want to move those estimates to a more liberal amount to where maybe they can pick up some net income.
More so than not though is where they’re not really paying attention to those. They may have a certain dollar amount in their AR reserve, for example, and they’re not really adjusting that on a monthly basis. So when they get to the end of the year, if they go back and look at the AR aging that we talked about before, maybe their AR reserve needs to be significantly higher because they’ve got a problem with a customer.
Those are kind of the surprises that we’ll see that, yeah, didn’t monitor it through the year. The end of the year when it comes to end of the year reporting, they have to make a big adjustment, increase their AR reserve or increase their inventory reserve.
Sam Clark:
So in your opinion, at what point do GAAP financials stop being useful for running the business?
Chad Sexton:
Yeah, I would say when you’re not using those, I mean, GAAP financial statements, typically for companies that we deal with, they’re doing it once a year. We do the audit, prepare the financial statements. Those are historical though. It’s a point in time for the balance sheet, and then we’re looking at last year’s results.
That’s not helpful when you’re already one, two, three months into the next year. So the financial statements really need to be looked at on a monthly basis, at least. It really should be something that is part of the decision-making process throughout the year.
Sam Clark:
Right, right. So let’s shift a moment and let’s go to risk. What are the quieter issues you see in manufacturing that don’t get attention until they become very painful?
Chad Sexton:
Yeah, the quieter issues are kind of those lingering fraudulent issues. That’s what comes to mind to me. And fraud impacts pretty much every business. Every business is at risk for occupational fraud. And typically, fraud occurs either from a lack of internal controls or an override of those controls. And you really don’t notice it until it becomes a problem.
Something could be going on for a long period of time. I do a lot of work in forensics and fraud investigations. And usually when I’m called in, that activity has happened for a year, two years, sometimes more than that. So it can go unnoticed for a long period of time, but then it stops being quiet and it becomes a real problem.
Sam Clark:
Right. But yeah, so basically a problem. So what do those problems tend to surface first like payroll issues, vendor kickbacks, purchasing incentives, those types of things?
Chad Sexton:
Right. Yeah. And I would say to think about it from any way that money can lead to business, whether it’s through payments through a check or an ACH. Some of the big things we’ve seen recently is in credit card, credit card transaction, or even employee reimbursements. Credit cards are a big, big issue. Anytime there’s employees that have company cards, that’s a risk. You’re basically handing cash to an employee to use.
I recently had a fraud investigation where an employee had taken a company credit card and used it for personal expenses. Nothing was very significant. All the transactions were I’d say less than a thousand. The majority of them were less than $500. But over a period of a couple of years, it accumulated to about $200,000 worth of embezzlement that he had. So exactly what you’re saying, it was a quiet issue, but it became a big problem when it was uncovered.
And like I said, the internal controls were in place, but he was able to override those controls. And there was really an issue where the transactions weren’t being reviewed and approved properly. And so that’s the control that I would recommend in all of these cases is that make sure you’ve got good review and approval processes. You mentioned payroll, that’s another big one.
A lot of our clients have a payroll service provider that handles all the payroll. That’s a good control to have, but also have some in house controls as well. One of the big ones is any access to that payroll system should be limited to specific and just a few people. One of the things that is always a risk is having a fictitious employee. So anybody that has access to the payroll system that can add an employee, there should be controls around that.
Periodically reviewing anybody added to the payroll system. Also, just having a business owner just review the payroll register, the payroll detail on a periodic basis. That’s easier for smaller companies, say less than 50. Owner probably knows most, if not all the employees. It gets more difficult when you’ve got hundreds or certainly thousands of employees.
You’re not going to know all of them, but there’s other things reviewing the total dollar amount or again, making sure that there’s limited access to that payroll system. The other piece would be approving hours work. There’s salary employees, hourly employees. There’s some companies that still use the old time clock system, so clocking in and clocking out.
Make sure there’s good controls around that and make sure there’s somebody approving that, yep, Sam worked eight hours today. Good controls around that as well. We should also talk about cybersecurity. That’s a hot topic right now as well in any business, but controls around cybersecurity. We are becoming more and more dependent on IT throughout the world.
And so cybersecurity is continually increasing as a risk. I have a client that recently went through a ransomware attack where they were able to get into their system, basically hold it hostage until they paid the ransom. This client was actually doing all the right things. They had good controls in place. They had actually outsourced their IT service and security to a company that was handling all that for them.
However, that company wasn’t doing exactly what they were saying. And so the backups that they had were not available. They weren’t doing the true backups. They weren’t monitoring the activity within the IT system where they would’ve been able to identify that yes, somebody had gotten in and breached the system. And so unfortunately, even though they were doing the right things, their service provider wasn’t. And so big disruption to the business.
They were down for several weeks. Fortunately, they were able to recover from it, but big disruption in the business that took a while to uncover and completely come back from. And statistically, those issues come up still from human error. So a lot of training needs to be in place. We have training on our end, knowing how to identify either a text message that may come through that’s malicious or an email, and really just asking yourself, does this look legitimate?
I actually got an email yesterday from a client. We had just finished the audit, so I wasn’t expecting any information from them, but they sent over a PDF that I was like, I’m not expecting an email from them. I don’t know why they’re sending it. So I just held onto it for a while. And a few minutes later they said, “Hey, don’t open this. Somebody hacked our system.” Just continually thinking about those things. I don’t need to go right into opening text messages or clicking on links. And so just to be mindful of that.
Sam Clark:
Right, right. Wow. So these risks do directly affect margins, cashflow, and lender confidence.
Chad Sexton:
Yeah, absolutely. Any kind of attack like that, it’ll disrupt the business. And then also there’s true financial impacts on those.
Sam Clark:
Right. Right. So let’s switch gears a little bit. Obviously this is a very, very hot topic, it’s on everyone’s mind, AI. Obviously, AI is getting a lot of attention in manufacturing right now. Beyond the buzzwords, what are your thoughts on where it’s actually making a difference?
Chad Sexton:
Yeah. Like you said, it’s a hot topic. Everybody’s talking about AI. Where we’re seeing it right now though is still in the early phases. Business haven’t fully adopted AI tools. Automation has been a topic for a while. A lot of companies are combining that with automation. Automation is more of the repetitive activities being done by machines. AI is more adaptive learning and almost making decisions themselves.
We are seeing where companies are moving from the pilot process into production. They’re still not fully implemented at this point, but most companies are expecting to invest in AI within the next three years. So it’s definitely coming. My advice would be it should be part of the conversation. Any kind of conversation with leadership, AI should be part of it. It should be an assessment of where could we most benefit from using AI?
There should be a cost benefit analysis in there. AI is not cheap. So really where are we going to see the most benefit? And that could be from cost savings, efficiencies, quality improvements. But the big thing is shouldn’t invest in AI just for the sake of investing in AI. There should be some plan in place to where companies are going to benefit from it. And then lastly, I would say part of that should be remembering the cost of implementation.
I’ve seen it many times where companies will buy a new software or a new system, ERP system, spend hundreds of thousands of dollars on the system, but really don’t follow through and get the appropriate training and integration in place. And so they’re not able to use that system to its fullest capabilities. So that’s where I think this could fall into that as well, just not fully adopting it or not getting the training in place to fully utilize that to AI tools.
Sam Clark:
Right. So it seems like to me, if an owner or a CFO was listening right now, the mindset should be, okay, do we experiment? Do we wait? Or do we go ahead and selectively invest? Right?
Chad Sexton:
Yeah. And I think all those could be the right answer. It depends. Every company’s different, different situations. But like I said, should be talking about it, should be part of the discussion. It should be part of the strategy of the business going into the future. It’s here. I don’t think it’s going away. We all have to learn how to use it though.
Sam Clark:
Right, right. So with current events, obviously with manufacturing industry, so we’re going to zoom out a bit, how much of what companies are experiencing right now is driven by external forces versus internal execution? For example, tariffs. Obviously that’s a hot topic. How are these tariffs showing up in cost, pricing, inventory strategy?
Chad Sexton:
Yeah, all of the above. Tariffs are a big topic. I feel like they’ve settled out over the past couple of months. But later in 2025, it was a huge topic. And I got some questions from clients, how do we handle this? Do we have to capitalize that in our cost of inventory? And so just having those conversations of how do we deal with it? And one of the things I talked about was, hey, you got to pay it. It’s here.
Should be part of your inventory, but you don’t always have to eat the cost of that. You should include that and passing that along to your customer when it’s appropriate. But instead of looking at it as, “Hey, I’ve got to pay this extra cost,” it could be something that you pass on to the customer or a portion of it. Again, every business is different, but just being able to see that, okay, it’s an extra cost. We got to include it in our sales price as well.
Sam Clark:
Right, right. With a manufacturing company, you look at a balance sheet, obviously equipment is very important to the execution of the operations of the company. So what are you seeing around equipment, investment timing, and tax incentives?
Chad Sexton:
Yeah, and that’s probably as big of a topic as anything is the tax law changes or the One Big Beautiful Bill Act. It’s also called the OBBBA, or recently I heard it, the OB3. I like the OB3, that kind of rolls off the tongue better. And I’ll give outside of my area of expertise pretty quick talking about taxes, but there are some good changes in the tax law in terms of bonus depreciation, Section 179.
Those are incentives to help with investing in equipment, getting to write off the costs earlier, which will in turn save on taxes. Those tax law changes though are complicated and there’s a lot of them. There’s also some other ones in there. Interest deductions is another one that you really need to plan for how you’re going to invest and also look at all the tax savings that could be available for you.
It’s not something you want to just say, “Okay, I’m going to save on this for taxes, so I’m going to go ahead and invest.” There could be some limits out there. You definitely want to talk with your CRI tax advisor on how to plan for that and how to strategize around your investments.
Sam Clark:
Right. Almost all industries are experiencing workforce shortages. In this particular industry, how does the workforce constraints affect financial decisions?
Chad Sexton:
Yeah, and that goes back again to AI. A lot of the tools out there are going to help with workforce or labor shortages, either to do two jobs quickly or could do jobs completely. We’re seeing that in our business to where we can be more efficient in those areas. And so may not replace a job, but it’ll elevate somebody to do a higher level job, a review of the tasks that the AI works on. Another big one is offshoring. There’s still instances where it’s cheaper. Labor is cheaper overseas than it is here. So those are two topics that are still part of the decision-making process.
Sam Clark:
Right, right. With the ups and downs of that supply chain, how does that affect revenue recognition or even an inventory strategy?
Chad Sexton:
Yeah, mainly on the inventory. If there’s shortages of your supplies, how you manage inventory. So like I said before, back in 2001, a lot of companies were buying up as much product as they could because they didn’t know if they were going to be able to get it if there were shortages. One, making sure those supply chains are open. Maybe looking at different vendors to get products, diversifying in that area.
And then it may be a good strategy to go ahead and buy some inventory that you think in the future may be short supply. The big thing again is on the strategy side to make sure that you’re paying attention to what’s out there. And if there are shortages, make sure you’ve got a plan in place to adapt to those.
Sam Clark:
Right, right. There’s an old saying, revenue is for show, profits for dough, and cash flow is always king. So where do you see manufacturing companies leaving money on the table?
Chad Sexton:
Yeah, a lot of times it’s in the area of taxes. We mentioned taxes before the tax law changes. We talked about the bonus depreciation. That’s really to save on taxes now versus waiting for the deduction for future years. Another one is on some tax credits. We’ve seen a lot of activity and cost segregation. So if you’ve got a business that’s building a new plant or adding a facility, that could be a good time to look at a cost segregation.
Again, to get quicker depreciation versus depreciating that building and everything in it over 39 years. If you take some of those components of the business, or sorry, the components of the facility, you may be able to depreciate those over a shorter life. So saving taxes early. Research and development credits are also out there. Any kind of tax credit. Business owners should be talking with their CPA to understand what’s available, what’s out there, and taking advantage when it makes sense.
The other area, we talked about tariffs, really understanding that the tariffs, the cost of those tariffs and passing those along to a customer. If you’re not thinking about it, if you’re just paying for the tariff and running it through and not really thinking about it, you’re going to eat that total cost and not be able to recoup any of that.
The last one is on succession planning and do a lot in Atlanta on transaction advisory services and really getting ahead of the game on… If you’re looking to sell the business within I’d say five to 10 years, it’s something that you should think about. What do you need to do now in order to get the best multiple when you do decide to sell the business? Or if you’re buying buying a business, making sure that you’re getting the best price and really planning for that.
Sam Clark:
So this really isn’t about doing everything, it’s about knowing what exists and when it actually matters. So if a owner or a CFO listens to this and does one thing differently next quarter, what should that be?
Chad Sexton:
Yeah. And I think again, like I said to begin with, really looking at the financial statements and understanding why behind the numbers. A business owner, it’s the language of the business looking at the numbers and really understanding what makes up the numbers, what trends are out there, looking at some ratios. If they’re not looking at those, really make that part of their normal process. We mentioned some of the forensic stuff that we do here.
That’s something that I’ve been involved in several times is as long as there’s cash in the bank, they may not look at the financials that heavily. And then when the cash runs out, they start asking the question, “Well, what happened? What happened to them in business? Where’s the money going?” And so then we come in and well, if you had looked at it for all this period of time, you would see these trends that are now making sense.
So really making that part of your operating process. And then also just a business risk assessment. I think that’s always a good idea, not only around internal controls. We talked about fraud and the risk around that. Looking at your business from a risk standpoint of what are areas that we’re open to risk, open to fraudulent activity, but also from an efficiency standpoint.
We talked about AI, looking at some of those areas where we could gain some efficiencies by adopting this policy or adopting this tool. So an overall risk assessment or efficiency assessment of the business. Again, I would gain knowledge on tax opportunities that are out there. Planning, planning ahead. It’s never too early to start planning for taxes. A lot of people want to wait until the end of the year, but sometimes that’s too late to do anything.
So really starting in first the second quarter to strategize on what that’s going to look like for the year so that you’re not up against any surprises at year-end. And again, just overall, just build a strategy for all of those and make sure you’re talking with your CBAs and coming up with good strategies. Again, so there’s no big surprises at the end of the year.
Sam Clark:
That’s a great place to land. Thanks for the conversation, Chad, and thanks to everyone listening. Hopefully this gave you a clearer, more practical lens on what’s really driving financial performance in manufacturing companies.
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