How to Increase Profit and Retain More Cash: Solving the Problem of Rising Supply Costs or Shortages
Chris Peden, CPA, CMA, CFM
I help small business owners grow their profits, cash flow and reduce their taxes by understanding their financials and creating an action plan to get there. Free Financial Assessment available (Link in “About” below).
If you’re a small business owner, you know that managing costs is critical to keeping your business profitable. One of the most common challenges you might face is the sudden increase in the cost of supplies or, even worse, the unavailability of key materials. When the supplies you depend on to produce your goods are delayed, unavailable, or become more expensive, your business can suffer. From manufacturing delays to cash flow problems, this kind of issue can ripple through your entire operation.
In my experience helping clients navigate these challenges, I’ve seen how rising supply costs or shortages can quickly eat into profits if not addressed early. If this is something you’ve been struggling with, you’re not alone. Let’s dive into the warning signs, the root causes, and most importantly, what you can do to fix the problem and prevent it from happening in the future.
Detecting Early Warning Signs of Supply Issues
It’s important to know the warning signs that supply costs might be going up or that a shortage could be on the horizon. If you catch these signs early, you can take action before the problem escalates. Here are some common signals that your business might be facing supply issues:
- You’re experiencing manufacturing delays due to a lack of raw materials or supplies.
- There’s low stocking of critical supplies, causing you to scramble at the last minute to fill orders.
- Supplier strikes or other disruptions are slowing down your supply chain.
- Your actual costs are starting to exceed what you budgeted for.
- You’re facing cash flow issues because you’re paying more for materials than expected.
- You’re struggling to meet customer orders, leading to dissatisfaction and potential loss of business.
If you’re noticing one or more of these warning signs, it’s time to take a closer look at your supply chain and start planning for potential disruptions.
An Example: How Supply Chain Issues Hurt a Small Business
Imagine the case of Sandra, who owns a small bakery specializing in custom cakes. Over the past year, Sandra noticed that the price of flour and sugar had been steadily rising, and her usual supplier had become unreliable, causing delays in fulfilling customer orders. Sandra tried to absorb the costs at first, hoping prices would stabilize. However, her profit margins started to shrink, and she was forced to decline orders due to supply shortages.?
After assessing her situation, Sandra realized she was overly reliant on one supplier and hadn’t adjusted her pricing to reflect the rising costs of materials. By diversifying her suppliers, locking in prices through long-term contracts, and slightly raising her prices to cover the increased costs, Sandra was able to regain control of her supply chain and improve her cash flow without losing customers.
Why Does This Happen? Diagnosing the Root Causes
Supply chain disruptions or rising costs can be caused by a number of factors. Understanding why this is happening is key to solving the problem. Here are some common causes:
- Strikes at your suppliers: Labor strikes can lead to production slowdowns or even stop the flow of goods entirely.
- Political unrest: If your suppliers are located in areas facing political instability, you may experience delays or sudden price increases.
- Inflation or economic uncertainty: Rising prices due to inflation can drive up the cost of raw materials.
- Poor materials planning: If you’re not accurately forecasting your supply needs, you may end up understocked or overpaying for last-minute supplies.
- Inaccurate budgets and forecasts: If your cost forecasts don’t account for possible price hikes, you might end up with budget overruns and cash flow issues.
Once you understand what’s causing the issue, you can take steps to address it.
How to Analyze and Evaluate Your Supply Chain Issues
Before jumping into solutions, it’s important to fully analyze the situation. Start by asking yourself a few key questions:
- Are you too reliant on one supplier? If your business depends on a single, unreliable supplier, you’re setting yourself up for trouble. Diversifying your supply sources can help prevent future problems.
??
- Have you had delivery problems in the past? Look at the history of your supply chain. Have you experienced delays or issues before? If so, it may be time to seek alternative sources.
- Are raw material costs increasing over time? Take a long-term view of your material costs. If the trend shows rising costs, you may need to plan for those increases or find ways to lock in lower prices.
- What’s happening with your production activity? If your production levels are dropping or fluctuating, try to pinpoint the reasons. Are they directly tied to supply issues?
Once you have a clear understanding of your current situation, you can move forward with a plan to fix the problem.
Solutions for Dealing with Rising Supply Costs or Shortages
When supply costs rise or materials become scarce, you need to act quickly. Here are some strategies you can implement to address the problem and protect your profitability:
Increase Your Selling Prices??
One of the most direct solutions is to raise your prices to reflect the higher cost of supplies. While this may seem risky, especially if your customers are price-sensitive, it’s often necessary to maintain profitability. Be sure to communicate with your customers about why prices are going up and what value they’re still receiving for their money.
Seek Alternative Suppliers??
If your current suppliers are unreliable or their prices have become too high, start looking for alternative sources. Diversifying your supply chain reduces the risk of being completely dependent on one supplier. You may also find cheaper or more reliable sources elsewhere.
Substitute Cheaper Materials??
领英推荐
If rising material costs are eating into your profits, consider switching to cheaper raw materials. Be cautious with this approach, though—make sure any new materials meet your quality standards and won’t negatively impact your product.
Improve Production Efficiency??
Another way to offset rising supply costs is to improve efficiency within your production process. Look for ways to streamline operations, reduce waste, and get more out of the materials you already have.
Take Legal Action if Necessary??
If a supplier has violated a contract by failing to deliver materials as promised, you may need to consider legal action. This can help you recoup some of the losses you’ve experienced due to supply disruptions.
Preventive Measures to Avoid Future Supply Issues
The best way to deal with rising supply costs or shortages is to prevent them from happening in the first place. By putting preventive measures in place, you can minimize the impact of supply disruptions on your business.
Stock Up on Raw Materials??
When prices are stable or low, consider stocking up on essential raw materials. This can protect you from sudden price hikes and ensure you have enough supplies to continue production during a shortage.
Enter Into Futures Contracts??
Another strategy is to lock in current prices by entering into futures contracts. This allows you to buy materials at a set price for delivery at a future date, protecting you from price increases down the road.
Consider Self-Manufacturing??
If you’re consistently having trouble sourcing certain materials, you might consider self-manufacturing those items. While this requires an upfront investment, it can save you money and give you more control over your supply chain.
Establish Long-Term Supply Contracts??
Entering into long-term contracts with reliable suppliers can help ensure a steady flow of materials at a predictable price. These contracts offer stability and reduce the risk of sudden shortages or price spikes.
Use Vertical Integration??
In some cases, it might make sense to acquire your supplier or invest in vertical integration. This means taking control of more steps in the supply chain to reduce price and supply risks. While this approach requires a significant investment, it can offer long-term cost savings and stability.
The Ripple Effects of Ignoring Supply Chain Issues
If you don’t address rising supply costs or shortages, the consequences can be severe. Here’s what can happen:
- Decreased profitability: Higher supply costs without corresponding price increases will directly impact your bottom line.
- Cash flow problems: Rising costs can strain your cash flow, making it harder to meet other financial obligations.
- Production cutbacks: If you can’t get the materials you need, you may have to cut back on production, which reduces your sales volume.
- Customer dissatisfaction: If you can’t fulfill orders on time or have to raise prices without warning, you risk losing customers to competitors.
- Increased risk and uncertainty: Rising supply costs or shortages add uncertainty to your business, making it harder to plan for the future and predict earnings.
Next Steps: What You Should Do Right Now
If you’re seeing the warning signs of rising supply costs or shortages, here are the immediate steps you should take:
1. Review your current suppliers: Are they reliable, or have they caused problems in the past? Consider diversifying your supply chain.
??
2. Analyze your material costs: Look at the trends in raw material costs over the last several years. If prices are rising, you need to plan accordingly.
3. Improve your production process: Look for ways to make your production process more efficient and reduce waste.
4. Consider alternative materials or suppliers: Explore cheaper alternatives or more reliable suppliers to reduce costs.
5. Plan for the future: Stock up on raw materials, enter into long-term contracts, or lock in prices with futures contracts to protect your business from future disruptions.
If you liked this post and want some help understanding your financials so you can grow your profits and cash, set up a call with me here so we can discuss your situation and how I can help:? https://calendly.com/pedenaccounting/right-fit-meeting
Are you struggling to keep more cash in your pocket? Check out my guide to managing expenses, maximizing deductions, and increasing revenue streams and provides you with actionable strategies to optimize your finances and enhance your cash flow:?