How Baker Tilly helped explain the unexplainable – manufacturing variances

Client background

Our client is one of the largest manufacturers of precision steel components in North America. The private equity ownership group sought to gather insights into the drivers of monthly variances in manufacturing cost and requested Baker Tilly’s support in identifying the drivers and recommending process enhancements to minimize them moving forward.

The business challenge

The company compiled financial results monthly and a common discussion point during results reviews was the capitalized variance account – where unfavorable manufacturing cost was accumulated and released as the product was sold. Over an 18 month period, the account grew and eventually reached a level where it was materially influencing monthly financial performance. The company was approaching the end of the fiscal year and sought to have a plan for how to explain the account for year end audit purposes and to determine how to objectively assess or eliminate the costs in the financial plan for the following year.

Turnover of key staff in the finance team had left a gap in process design knowledge and how variances could be explained, so the client reached out to Baker Tilly to see if we could interpret the financials and identify root cause of variances.

Strategy and solution

Baker Tilly reviewed the company’s cost process by looking at a trove of financial and operational data furnished by management. We reviewed detailed machine hours logs to evaluate capacity utilization at the facility. General ledger data was analyzed at a transaction level to identify significant trends in key manufacturing cost categories such as labor and facilities costs.

Within a few weeks, we identified key factors including a loss of business and a change in manufacturing processes that materially impacted how manufacturing overhead was absorbed. As a result, the client was able to move forward with the following improvement opportunities:

• Baker Tilly’s analysis provided the client a detailed understanding of the weaknesses within its costing process and greater understanding of the influence of new or lost business on its financial reporting.
• The firm’s recommendations to update costing process allowed the client to reduce unabsorbed manufacturing overhead by 55%.
• Improved precision of costing data at an item level provided more accurate information to inform quoting processes on new business, improving order profitability.
• Baker Tilly helped align ownership and management on the proper treatment of unabsorbed manufacturing overhead and recommended enhancements for the costing methodology going forward.