Profit on the balance sheet, but no cash: why?

... And what do planning and accounting have to do with it?

“Why do we need automation if it doesn’t generate profit?” This is a question we often hear from company executives.

Ruslan Marinov, a business analyst at systems integrator Tsifrovizatsiya Proizvodstva (CIFP), gave a detailed answer with examples.

Where a business begins

In Russia, a manufacturing entrepreneur starting out usually tries to do everything personally, because there is no funding for large production, finance, and sales departments. They hire an accountant who somehow balances the books and files the reports, deal with customers themselves, and prepare the design documentation if it is needed.

But startups miss one thing: today your business may bring in, say, RUB 10 million (≈ $100,000), but in 2–3 years it can shoot up to RUB 200–300 million (≈ $2–3 million). And if you don’t lay the right foundation from the start—at least a basic accounting system—it will seriously hurt profitability.

If the owner is used to taking parts from the warehouse without recording it anywhere, because they “run it all themselves,” “keep it all in their head,” “don’t have time right now,” and a million other reasons, employees will do exactly the same. Later on, no single employee will be able to turn it all around. It is always easier and cheaper to do things right from scratch than to redo them and clean up a mess. If you have trained yourself to keep at least minimal records, even in a spreadsheet, then when production grows and a dedicated warehouse employee comes on board, they will simply continue the established routine. Manufacturing companies built on the right idea grow very fast.

So the first and main piece of advice for entrepreneurs starting out is to think about how you will keep track of materials, money, people, and so on. All of this needs to be systematized right away, with procedures and rules in place, even the simplest ones.

Millionaires on paper, but in real life?

Entrepreneurs usually look at profit on the balance sheet. But they don’t account for the money tied up in dead stock frozen in warehouses as a result of poor planning. The balance sheet may show, for example, an asset—inventory up by RUB 100 million (≈ $1 million)—while in reality you have lost RUB 100 million (≈ $1 million). Why?

When fulfilling a large contract, companies build in a buffer. The weaker a company’s recordkeeping, the bigger the buffer in materials purchased for the contract. When a company plans, it knows exactly how much material it needs and what percentage of finished products will be defective. If it knows its buffer range, for example 5%, it can increase inventory by 3%. After all, it may not even need that stock.

If a company doesn’t plan and doesn’t have sophisticated systems for planning, it simply cannot plan correctly. Example: a company signs a RUB 10 million (≈ $100,000) contract. Materials should cost, say, RUB 5 million (≈ $50,000), taxes RUB 1 million (≈ $10,000), and other costs RUB 2 million (≈ $20,000). That leaves a profit of RUB 2 million (≈ $20,000). It looks good on paper. In real life, we have to buy extra stock, because we don’t know exactly how much material production will need. Entrepreneurs who don’t keep records or plan usually add a 30% stock buffer. As a result, they buy RUB 6.5 million (≈ $65,000) worth of materials instead of RUB 5 million (≈ $50,000).

So on margin we earned RUB 2 million (≈ $20,000), but RUB 1.5 million (≈ $15,000) of it is buried in the warehouse.

On top of that, everything stored in the warehouse gets more expensive by RUB 1,000 (≈ $10) per square meter at Moscow rental rates. Over 3 years, a pallet of 1 cubic meter costs an extra RUB 36,000 (≈ $360) to store, while its contents may have originally cost just RUB 10,000 (≈ $100).

This is how the entire margin gets eaten up at companies that are used to working on paper and don’t want to plan production, sales, procurement, and all their other business processes.

There comes a point when the company has kept growing and growing, and now the warehouse is overflowing with obsolete stock. Something has to be done, because inventory costs us more year after year, yet no one can bring themselves to throw it out.

Eventually, auditors come to a company with a RUB 100 million (≈ $1 million) balance sheet, check inventory turnover, and say that 80 million out of the 100 isn’t moving, can’t be verified, and must be written off. A committee has to be set up to write it all off as obsolete stock. And it turns out that the “paper” profit doesn’t actually exist. There is no money for growth or equipment, and you can’t give employees a raise. Qualified staff leave.

And the whole problem is the lack of competent, modern accounting and planning. You need to understand that a certain percentage of every ruble earned has to be spent on putting things in order.

I always recommend this: start spending money on proper accounting systems right away—it’s cheaper. Cleaning up the mess later will take a long time and cost a lot. And putting things in order, in turn, leads to layoffs. It is much harder to make an employee work in a new way than to hire someone new under the new rules from the start.

Nobody likes change

Nobody likes change. Likewise, companies turn to automation only when they need to increase profits. And even then, far from everyone understands this need. Very often we hear from short-sighted executives: “Why should I invest so much money in automation if it doesn’t generate profit?” True, automation won’t earn you money directly, but as the saying goes, a penny saved is a penny earned.

To keep high-quality records, you need qualified staff. Employees who have worked on paper for 30 years won’t dig into new technology. So to hire qualified people, you have to pay competitive salaries.

When does a company realize it needs automation?

When it fails to deliver on a major contract.

Only a company with well-established business processes can fulfill such a contract quickly. Example: a company wins a RUB 1 billion (≈ $10 million) contract with a 3-month deadline. How do you calculate how much material you need? Without automation, you do it by hand. With an ERP system, for example, where everything is set up correctly, bills of materials are in place, and operational accounting is fully covered, it can be done in a day. Tomorrow you start negotiating with suppliers, and the day after, they confirm delivery dates. In a week, the first containers are on their way to you, and in 3 weeks you start production.

Now take automation out of the picture. Everything is “on paper,” and an employee in the production and technical department enters everything into spreadsheets. Just calculating the contract will take them a month.

The need for automation arises where there is big money and tight deadlines.

A big mistake manufacturers make is thinking that automation will let them work less. No! Whether they will work better is more a question for the integrator: how well it models the business processes and how well it implements the software.

What does working better mean? You will earn more money, handle fewer claims, and shorten production lead times.

The need for automation quickly becomes clear when a company fails to deliver on a billion-ruble contract because it misses deadlines and penalties start to accrue. There are also politically important contracts, where the same contract was also given to 2–3 of your competitors. They delivered, and you didn’t. That is when claims arise, and next time you won’t get such contracts.

Another way companies realize they need modern automation: the head of a company with RUB 1 billion (≈ $10 million) in revenue and 5,000 sq. m of warehouse space visited peers and toured their plant. He saw that, with the same production, they had revenue of RUB 2 billion (≈ $20 million) but only 1,000 sq. m of warehouses. How did they do it? It all comes down to competent accounting and planning, which is only possible when production is automated down to the last detail, down to the minute.

Thus, a company’s level of automation is directly proportional to its profit growth.

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