Manufacturing: Beware of Excessive Debt

I spend a lot of time in manufacturing facilities in Massachusetts, Rhode Island and Connecticut. My company consults, sells manufacturing companies and performs machinery and equipment appraisals. Contrary to the general public’s perception, the manufacturing sector in the U.S. is alive and well and serving many niche markets.

American manufacturing, except for several recession years, has been growing steadily and significantly since the early 1970’s. The United States is producing more durable goods today than ever. Each month of 2013 saw a record high for that month in the durable goods index.

Current manufacturing company owners could certainly benefit from some of my recent discussions and observations in the sector. Many manufacturers are achieving good results, and maintaining their customer base, have skilled employees, a strong sales force and have healthy profitable operations. But recently I have seen several manufacturers who have fallen into very similar financial traps.

Recent visits to three manufacturers have resulted in the same unfortunate tale. They basically had overspent for capital equipment in their factories and were having difficulty “digging out” from beneath their substantial debt load. In one case the company had a debt balance that was higher than their annual sales revenue!

Investing in machinery and equipment is a “double edged sword.” You need to upgrade machinery to produce goods in demand by your present customers and to impress new customers and be competitive in your marketplace. One plant purchased a $250K Robotic Cell and has used it for one job and it has sat idle for four months since!

The problem or trap for these owners has been continuing to buy machinery for which they were able to receive loans. They receive a new machine and make future monthly payments to pay down the debt. They keep purchasing equipment and their debt continues to rise.

The problem escalates when their production volume is not meeting their plan or they lose a couple of key customers. They begin to drown in debt while they struggle to pay their monthly loan payments.

These owners will be the first to criticize the banks for tightening their belts and scrutinizing the company’s performance. When the key financial ratios fall below industry standards there are legitimate concerns on the lenders side. Does the company have the ability to survive and meet their debt obligations? You cannot blame the bankers for their concerns as they have seen many failures before.

When an owner wants to sell their company a related problem occurs. Their machinery and equipment or hard asset values actually exceed the basic value of the company. Now you say how can that be? It’s easy! The hard assets are not producing the sales volume that they should combined with low profitability. A classic example of negative goodwill. The overall business valuation suffers along with the proposed asking price for the company.

So be extremely careful with new machinery purchases. Do your homework and be sure your company can truly afford it going forward before making a financial decision you will have to live with for years.


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