How financially fit is your food manufacturing or distribution company?
We know we’re preaching to the choir, but this industry is defined by its tight margins and complex supply chains. That makes your balance sheet, income statement and statement of cash flows powerful diagnostic tools to help evaluate your overall financial well-being.
A little analysis can go a long way to uncovering potential money management problems, inventory management challenges, cash flow constraints or even fraudulent activity.
The balance sheet: What you own vs. what you owe
A balance sheet is a snapshot of your company’s financial health at a moment in time. One side shows the assets owned by your business, such as cash, finished goods and specialized equipment like processing lines and packaging machinery. The other contains liabilities or claims on those assets, including accrued expenses, accounts payable to suppliers, equipment loans and lines of credit.
Current assets (such as receivables and perishable inventory) mature within a year, while long-term assets (such as cold storage facilities, distribution centers and refrigerated transport fleets) have longer useful lives. Similarly, current liabilities (such as payables to ingredient suppliers) come due within a year, while long-term liabilities are payment obligations that extend beyond the current year or operating cycle.
Net worth or owners’ equity is the extent to which assets exceed liabilities. Because the balance sheet must balance, assets must equal liabilities plus net worth. And if the value of your company’s liabilities exceeds the value of its assets, your net worth will be negative.
The income statement: Understanding revenue and expenses
The income statement reports revenue, expenses and profits earned (or losses incurred) over a given period. A commonly used term when discussing income statements is “gross profit,” or the income earned after subtracting the cost of goods sold from revenue.
For food manufacturers, cost of goods sold includes raw materials (which can fluctuate dramatically with commodity prices), direct labor and production overhead like energy costs for refrigeration and processing. Another important term — “net income” — describes income remaining after all expenses (including taxes) have been paid.
Sales, general and administrative expenses (SG&A) are also indicated on income statements, reflecting business functions such as marketing, regulatory compliance and quality assurance that support your company’s production and distribution. The ratio of SG&A costs to revenue tends to be relatively fixed, no matter how well your business is doing. If these costs constitute a rising percentage of revenue, business may be slowing down.
The income statement can reveal other potential problems specific to food manufacturing. It may show a decline in gross profits as expenses rise quicker than revenue. Common causes include rising transportation and logistics costs, increased energy expenses for temperature-controlled environments or doing an excessive proportion of low-margin private label business.
The statement of cash flows: Managing cash across borders
The statement of cash flows shows all the cash coming in and out of your company. Your business may have cash inflows from selling products, borrowing money and selling stock. Outflows may result from paying expenses, investing in processing equipment or distribution infrastructure and repaying debt. Ideally, your company will derive enough cash from operations to cover its expenses. If not, it may need to borrow money or sell stock to survive.
For international food manufacturers and distributors, cash flow management becomes more complex. You’re often dealing with multiple currencies, which means foreign exchange fluctuations can impact your cash position. Payment terms with international distributors may extend 60-90 days or longer, whether it’s shipping across oceans or sitting in customs, tying up working capital without generating revenue — yet.
The statement of cash flows shows changes in balance sheet items from one accounting period to the next. It’s organized into cash flows from three primary sources:
- Operations, including collections from customers, payments to suppliers and employees, and operating expenses
- Investing activities, such as purchases of processing equipment, cold storage expansion or fleet vehicles
- Financing activities, including loans, lines of credit and equity investments
Non-cash investing and financing transactions are reported at the bottom of the statement of cash flows. These transactions don’t involve direct cash exchanges. For example, equipment that’s purchased directly with loan proceeds would be reported here.
Although this report may seem similar to an income statement, its focus is solely on cash. A product shipment to an international distributor might appear as revenue on the income statement, even though payment won’t arrive for another 60 days. But the money from the sale won’t appear as a cash inflow until it’s collected and converted to your home currency.
Maintaining fiscal wellness
Financial statements can be valuable for many purposes, especially if you’re evaluating the financial results of your own business or one that you’re considering investing in. And in the food manufacturing and distribution industry, they become even more critical for spotting challenges early on.
Reach out to the food industry CPAs at Magone & Company for a comprehensive assessment of your company’s financial health.
This document is for informational purposes only and should not be considered tax or financial advice. Be sure to consult with a knowledgeable financial or legal advisor for guidance specific to your unique circumstances.