In 2023, there was continued growth for privately-held companies in the manufacturing and distribution industry. In 2024, these companies are expecting overall modest growth in addition to a surge in product and production costs due to a rise in the price of raw materials. They also anticipate increases in employee wages, health insurance costs, and overall business expenses because of inflation. For the most part, companies came out of the last three years with stronger balance sheets, a more resilient supply chain, additional working capital, and a stabilized focus going into this year. Now, efforts in 2024 will concentrate around managing these increasing costs while capitalizing on new growth opportunities.

Legislation and regulations impacting the industry

The manufacturing industry has been utilizing benefits provided through new legislation, like the Infrastructure Investment and Jobs Act (IIJA), the Creating Helpful Incentives to Produce Semiconductors (CHIPS) and Science Act, and the Inflation Reduction Act (IRA), which were signed into law in 2021 and 2022. These laws are focused on clean energy initiatives, building the U.S. semiconductor industry, and rebuilding U.S. infrastructure. For semiconductor-related companies (i.e., clean energy, electric vehicles, batteries, and all related components), there are significant funds, grants, and tax incentives available geared towards the private sector. Also, funds like the supplier development fund, created by the U.S. Navy, have been established to bolster the U.S.’ infrastructure and defense capabilities. The government is further expanding funding opportunities to support the manufacturing community that is committed to servicing the government’s defense initiatives, creating significant avenues for private companies to invest in their future.

Impact of inflation, research and development capitalization, and interest rates

2022 saw the beginning of interest rates increases, followed by a sharp increase during 2023. It finally appears that interest rates are settling and will potentially decline in 2024, but the days of historically low interest rates are behind us. Private companies who benefited from significant government assistance via the Employee Retention Credit (ERC) or Paycheck Protection Program (PPP) loans over the last three years have been able to soften most of the impact of inflation and increased interest rates, coming out with stronger and healthier balance sheets than before 2020.

There is continued inflation pressure on all fronts, from labor, insurance, and healthcare costs to product costs. Companies are now starting to see a significant increase in their overall interest expense, along with delays in their cash conversion cycle as vendors and customers seem to be extending payment terms. These costs are significant and need to be factored into not only go-forward projections but overall product costs when considering customer pricing and the overall cost of running your business.

For companies that have seen a drop in their income for 2023, there has been an increase on disallowed interest expense under Internal Revenue Code (IRC) Section 163(j) (interest expense limitations), causing an increase in overall taxable income for the year. Also, IRC Section 174 calls for companies to capitalize certain research and development expenses and amortize them over a period of five to 15 years depending on where those services are being performed.

All of these additional tax changes should be forecasted and planned for as manufacturing and distribution companies could face higher effective tax rates for 2023 and into 2024. The Manufacturing and Distribution Industry Practice at Citrin Cooperman is keeping an eye on potential tax law changes to ease the financial pressure they may create for the industry.

Managing inventory levels

In the 2023 Fourth Quarter Manufacturers’ Outlook Survey performed by the National Association of Manufacturers, 45% of companies are predicting a continued decline in their inventory levels in 2024. This represents a continuation of the decline over the past year following a major upswing in inventory levels at the end of 2022. The entire industry model changed drastically in Q1 of 2023 from a model where customers just needed access to product at all costs to companies having excess product on hand as supply chains re-opened. This led to 2023 profit margins decreasing overall while companies had to start working through their excess inventory balances. Since most of these inventories are still relatively current – being that they were only bought in the past year – companies should focus on their inventory age by product to ensure no unforeseen issues are building up.

Navigating continued labor challenges

Attracting and retaining top talent will be a key focus again this year. Companies are offering flexible scheduling to production workers via remote work, if it is available for the position, compressed workweeks, and the opportunity to swap or split shifts. Flexibility plays a part when looking at hiring for executive positions or management team members too. Additionally, more companies are turning to outsourced roles to support growth or acquisitions. These roles allow more of a plug-and-play mentality, where companies can bring in supportive services when needed and flex those positions up or down depending on the required impact.

Embracing change

There has been significant investment in new enterprise resource planning (ERP) systems, forecasting technologies, and inventory management tools over the past few years. This trend will continue to increase as companies focus on the ability to better predict their customers’ needs and manage their inventory pipeline, whether that is through artificial intelligence (AI) or improvements in their inventory software. These investments can truly transform a business and the overall dependency they currently have on manual procedures. If a company can better forecast their inventory balances, they create the opportunity to pass that transparency on to their customers, improving the customer experience. These tools can also create real-time financial statement projections along with preparing borrowing base certificates and financial covenant projections that companies may need to satisfy their borrowing or ownership requirements.

Fears of a projected recession seem to have subsided for 2024, and companies have finally settled in after several years of instability. This improved optimism comes with overall cost increases, leaving companies to focus on cost management in the year ahead. Assessing the value businesses are getting from their employees, suppliers, and vendor relationships will be key in 2024, while also continuing to expand operations and make capital investments.

Citrin Cooperman’s Manufacturing and Distribution Industry Practice is one of the leading practices in the country. Our dedicated team leverages specialized knowledge to provide a full range of professional services and industry insights to help companies achieve success. These insights include the annual release of our Manufacturing and Distribution Pulse Survey Report, which provides leaders in the industry with the information they need to enhance their business, improve their decision making, and prepare for obstacles ahead. Explore what your peers had to say in our 2023 survey report, and stay tuned for the 2024 edition, which will be released in May 2024.

If you need assistance with any of the topics discussed in this article, please contact your Citrin Cooperman advisor or Mark Henry at mhenry@citrincooperman.com.