When manufacturing catches a cold, the rest of the country gets pneumonia.
That’s why the economy and inflation – the top two concerns of most Americans – are high on the list of manufacturers’ issues as well, because beyond the effect on their businesses, what happens to manufacturers ripples across the rest of the U.S. economy.
Historically, manufacturing makes up between about 11-13% of U.S. gross domestic product, which in 2021 factored out to about $3 trillion. A few months ago, manufacturers were dealing with an inflationary environment that was described as “transitory” and “short-term.” Last spring, the Federal Reserve was talking about higher inflation – but nothing like what we’ve seen.
A Federal Reserve Bank of St. Louis economic synopses, published in May 2021, shows how fast things can go wrong: “Chair Powell and most FOMC (Federal Market Committee) members have been conditioning the public and financial markets to expect inflation to rise temporarily beyond the FOMC's 2 percent inflation target this year. The March ‘Summary of Economic Projections' embodies this view: The median FOMC participant expects headline PCEPI (Personal Consumption Expenditures Price Index) inflation of 2.4 percent in 2021, slowing to 2 percent in 2022 and 2023.”
By late in the year, the Federal Reserve dropped “transitory” from its inflation description, and 2021’s inflation rate clocked in at seven percent, the highest in 40 years. But manufacturers – and a great many other businesses – made inventory, purchasing, sales, and other economic forecasts based on the earlier best estimates of economic experts, projections that were wrong.
The last major inflationary period began ratcheting up in the mid-1960s and reached its highest level, 14.8%, in 1980, before tailing off. Everyone is trying to figure out how long this present phase will last.
With all the prognostications being made, someone is bound to be right. But who?
In the world in which manufacturers live, there are several possible macro ways to deal with an inflationary environment. One issue is how much the company is spending, where, and why, with a fourth element: Is it necessary? This analysis, called spending visibility, is a form of in-depth accounting and projecting.
Spending visibility is obtaining precise data on a series of company financial activities to get a clear picture of prices paid to materials suppliers and vendors, materials sources, purchasing frequency, percentage of on-time and agreed price deliveries, and how these amounts compare with other fiscal or calendar years.
There are overarching uses for the information gleaned from a spending visibility effort: first, it identifies areas where money is being wasted or can be saved; second, it provides information for investment in infrastructure, employee costs, and other areas; third, it’s broader data for long-term financial projections. The more knowledge in-hand, the more flexibility it can give company leadership for decisions, including responding to inflation. Another tactic is to review how much coordination goes on within the company between divisions responsible for purchasing, procurement, and improve it.
With respect to manufacturing inflation forecasts, those are influenced – to the degree they can be – by the Federal Reserve’s tactic of attacking inflation by raising interest rates to tighten the money supply. Higher interest rates mean a higher cost of borrowing. Manufacturers would be well-served to consider refinancing debt, if they haven’t already, given recent historically low interest rates. However, there are always some holding out for even a better rate or waiting for what they think is a better time. It’s a gamble either way, but the chances are low of rates declining in the foreseeable future.
High inflation is here. For how long, no one knows. Manufacturers can create a better future for their companies by engaging an experienced accounting organization that can employ these tactics, and others, to keep from getting an inflation-induced cold, or worse, pneumonia.
This article first appeared in KnoxNews.
