How metal fabricators make the most out of narrow margins

During a late fall webcast, hosted by the Fabricators & Manufacturers Association Intl. (FMA), Steve Zerio, a partner with Novi, Mich.-based Triumph Partners, showed an eye-opening pie chart that broke down where the sales dollars go at a typical custom metal fabricator. Taking out the cost of material, direct and indirect labor, overhead, and sales expenses, fabricators are left with a 4% margin. “That profit has to go a long way,” he said. “We need to be careful how we manage it.”

Zerio got his numbers from FMA’s latest “Financial Ratios and Operational Benchmarking Survey,” a detailed study that dives deep into the financials of more than 40 anonymous participants from the industry. The study, released in fall 2021, covered the 2020 fiscal year—admittedly not a typical year for most fab shops. Up until 2020 the average operating profit in the study fluctuated between 5% and 10%. Considering all that happened in 2020, it’s easy to understand why margins narrowed.

Sales growth did an about face too. In 2018 fabricators that participated in the survey enjoyed an average growth rate of nearly 14%; in 2019 they grew another 9%. But in 2020 sales fell by 14% on average—a significant drop, but not terrible considering the circumstances.

Sales growth numbers for 2021, to be covered in next year’s survey, may well be off the charts, at least for some. But there’s a hidden danger here. The late Dick Kallage, a longtime industry consultant and former columnist for this magazine, said he saw so many companies fail not during the depths of a downturn, but during the rebound. They simply didn’t have enough cash to cover the increased costs incurred to satisfy skyrocketing customer demand.

Hence Zerio’s focus on managing the cash generated by that 4% profit and its cousin, EBITDA (earnings before interest, taxes, depreciation, and amortization) margin. Average EBITDA margin in 2020 was 8.7%, down from 10.1% the year before.

Such margins fuel what Zerio calls the financial cycle: Cash flow improves the balance sheet, spurs reinvestment, which in turn drives revenue, busier (and, ideally, more efficient) operations, which produces higher margins, boosts cash flow—and the virtuous cycle continues.

Several key metrics from the latest survey stood out. The first detailed sales dollars gained from new customers. It’s a significant measure of growth and financial stability, considering the high revenue concentration at many fab shops. In 2020 the average from the study rose to 7%; that’s 2 percentage points higher than in 2019. The rise might be attributable to the pandemic-induced drop and dramatic rebound during the roller coaster that was 2020, when customers scrambled to find suppliers to meet rapidly increasing demand.

Zerio also pointed out the metric related to customer returns as a percentage of sales. The average for 2020 was just 0.5%, down from 1.3% in 2016. This was a huge and important improvement, especially considering that in most situations, the indirect costs of customer returns far outweigh the direct costs. “Say you’re tracking your return credits,” Zerio said, “and say for one job you deliver the wrong part or one that doesn’t meet quality standards. So you credit your customer $800. But in reality, your true costs are five to 10 times that. You’re solving quality problems, and you need to expedite and ship replacement parts. So many costs go into customer returns.”

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