Risk

Article Dean Dorton

The Manufacturing industry faces challenges and risks that are unique from any other industry. Since manufacturing is a vital spoke in the global economy and an essential component of many other industries, risks to manufacturers tend to have a much larger ripple effect. If risks go unaddressed they can lead to operational and financial losses throughout our economy, not to mention damage to the reputation of the company. It’s important for manufacturers to be aware of the basic and evolving risks they may face and take appropriate steps to mitigate them.

Some key risks include:

  • Supply chain constraints
  • Attracting and retaining quality workforce
  • Cyber security threats
  • Inflation


Our team of Manufacturing Experts have put together a risks overview so you can explore the risks to the manufacturing industry in detail and search for opportunities for growth as we cruise through 2023.

Risk Description
Supply Chain Constraints
Parts/materials difficult to find/long lead times.
  • Acquire logistics companies or develop in-house logistics operations. Greater supply chain visibility and higher quality as well as reducing shipping costs and time due to more streamlined logistics networks
  • Consider new suppliers and sourcing options
  • Relationship management
Attracting & Retaining Quality Workforce
Labor challenges experienced through a shrinking pool of applicants, aging workforce and shortage of highly skilled workers.
  • More favorable working conditions including pay increases and flexible work arrangements
  • Diversity, Equity & Inclusion (DEI) approach to attract more women and racially and ethnically diverse groups
  • Manufacturing companies today have a hard time finding employees who will show up and be on time for work and stick with their jobs
  • Considerable void when it comes to skills and experience – Manufacturers need to work with schools and universities in their communities to ensure that manufacturing focused subjects are being well promoted and taught
Cyber Security
Rise in cyber security incidents across manufacturing companies.
  • Potential effects of a network infiltration include shut down of operations, theft of sensitive customer information, or theft of sensitive banking information
  • Education of employees of potential phishing schemes is paramount to a successful cyber security campaign
Technology
Technology continues to evolve with endless possibilities.
  • Take ERP to the Cloud
  • Data analysis predictive maintenance and use of data analysis to identify anomalies in equipment performance
  • Data decision making around sourcing, production, fulfillment, cost reduction.
  • Controls around Artificial Intelligence
  • Autonomous vehicles in warehouses to move materials and product
  • Robots will change the economics of manufacturing with less time focused on low cost labor positions
Environmental, Social, Governance (ESG)
A sustainability mind-set becomes more of a focal point.
  • Complete visibility throughout supply chain for own compliance and that of their suppliers
  • Manage waste
  • Increase supplier diversity
  • Smart buildings
  • Electrifying fleets
Product as a Service (PaaS)
Diversifying revenue sources has become more important in establishing an indefinite future.
  • Manufactures lease equipment to customers and offer a list of subscription based value-added services
  • Collect equipment usage data from customers
Inflation
Manufactures have to integrate higher priced materials into budget and determine how much to increase prices to customers to absorb these cost increases.
  • Producer price inflation for goods other than food and energy slowed to an annualized 4.2% in the three months ending in December 2022 from 11.5% in the three months ending in April 2022. (Reuters)
  • Manufacturing payrolls increased at an annualized rate of 1.6% in the three months ending in December, down from annualized growth of 5.5% in the three months ending in April. (Reuters)
Possible Recession
Managing through a potential slowdown in the economy will be a focal point of 2023.
  • Sixty-two percent of manufacturers expect the U.S. economy to enter a recession in 2023, according to a survey conducted by the National Association of Manufacturers

Manufacturing Services

Article Dean Dorton

President Biden’s tax plan could shake-up many real estate investors’ and developers’ tax obligations. Due to Democratic control of the White House, Senate, and House of Representatives, the possibility of changes to the tax law may become a reality, however when and to what degree is unclear due to President Biden’s priority being addressing COVID-19.



The potential financial implication of the proposed tax plan may stretch to all facets of the real estate investor community. If passed, investors and developers may want to reexamine their entity structure as well as their tax planning strategies.

In President Biden’s tax plan, he has proposed:

  • Elimination of the $25,000 exemption from the passive loss rules for rental real estate losses for certain individuals
  • Eliminate like-kind exchanges that allow deferral of capital gain taxes on the exchange of appreciated real property for taxpayers earning more than $400,000
  • Eliminate faster depreciation for certain property 
  • Eliminate or phase out Qualified Business Income (QBI) Deductions for profitable rental real estate activities where taxpayers earn more than $400,000
  • Tax capital gains as ordinary income for taxpayers with over $1 million in income
  • Reforming Opportunity Zone initiative by:
    • Incentivizing Opportunity Funds to partner with non-profits within the Opportunity Zone
    • Require benefits to be reviewed by the Treasury Department to ensure the benefits are only allowed where there are economic and social impact to a community
    • Require recipients of the incentive to provide detailed reporting and public disclosure of their investment and impact on the community

We will continue monitoring the situation as President Biden’s plans take shape. For a comparison of Present Law to President Biden’s Proposal, please click below:

Tax Plan Comparison

Becky Hughes, CPA, MACC
Tax Director
bhughes@deandorton.com • 502.566.1039

Article Dean Dorton

Key Risks and Opportunities for Electric Co-operatives in 2021:

Cybersecurity and Big Data

Co-operatives need to be proactive in cybersecurity by implementing effective controls to prevent and detect cyber-crime. The increased need to work remotely due to COVID-19 has elevated the importance of secure remote connections.

Power Supply Costs

Management needs to continue to investigate alternative sources of energy, such as wind, solar, biomass, etc., to further diversify power sources as well as work with communities to deploy energy storage and efficiency technologies.

Safety, Including Overtime Management

Safety is a major concern for co-operatives as their employees routinely work in dangerous conditions (i.e. downed power line in a thunderstorm) that, if not taken seriously, can expose the co-operative.

Community and Environmental Responsibility

Electric co-operatives have to balance providing affordable electricity to the communities they serve while protecting those same communities from environmental deterioration. ESG (Environmental, Social and Governance) programs will become more prevalent by stakeholders.

Succession Planning

As co-operative executives continue to grow older and retire in larger numbers than in the past, there must be a greater emphasis on succession planning and staff development.

COVID-19 Impact

COVID-19 has led to a decline in electricity demand and elevated customer collection concerns Additionally, supply chains have been hampered which has slowed the delivery of key materials, especially those coming from overseas.

Adoption of the New Lease Standard

Co-operatives will need to adopt ASU 2016-02 (Leases) in 2022.

Article Dean Dorton

Operators need to monitor the following risk areas to stay competitive 2021:

1. Cybersecurity

Convenience stores should comply with PCI standards in order to protect cardholder information. Also be aware of skimming, in which devices are affixed to gas pumps and ATM machines to steal credit card information. C-stores should implement procedures to monitor pumps and ATM machines, and prevent and/or remove such skimming devices. Additionally, establish controls around the use of artificial intelligence to better understand consumer buying habits. Companies have until April 17, 2021 to comply with EMV chip card technology. Companies should invest in a proactive cybersecurity program which includes training programs to educate employees on common phishing scams.

2. Social Media & Mobile Technologies

Social media is increasingly becoming a part of everyday life. Incorporating social media into your business model can improve customer service and provide a low-cost alternative to traditional advertising. More than half of all buying is expected to occur on mobile devices. Therefore, having mobile applications is crucial to achieving success. Incorporating a rewards program in an app can lead to customer loyalty and increased sales.

3. Food Service

Food service sales continue to drive the success of the convenience store industry, and you risk losing out on business if you do not invest in food service. Because customers are looking for healthier food options, the c-store industry has seen large sales increases in “better-for-you” items, with lunchtime traffic as the biggest opportunity. Continued trends in 2021 are going green, customization, unique experiences, healthy options, and tech takeover.

4. Wage Rates

The focus on driving up federal and state minimum wage requirements will get additional attention as the U.S. sees a transfer of power in Washington D.C.

5. Regulation Compliance

Increased regulation may result in higher prices for products such as e-cigarettes and other vapor products, diet and energy drinks, and dietary supplements, or a ban on those products altogether. Convenience stores must also comply with regulations regarding sales of alcohol, tobacco, and lottery tickets or face serious fines and penalties.

6. Softening Tobacco Market

While the tobacco market is stable, cigarette consumption is slowing as consumer demand flattens. E-cigarettes can be an important product line in c-stores, as almost half of adult smokers are looking for an alternative to cigarettes. Cigarette taxes have been rising, which will impact demand as well.

7. Shortage of Truck Drivers

The average age of a truck driver is 55, so all industries need to work together to identify an expanded labor pool. Currently community colleges are expanding programs along with a focus on female and military veteran drivers. The shortage of truck drivers can create delays in shipments to stores, inventory shortages, and frustrated customers. The LA Times reports 1.7 million American truck drivers could be replaced by self-driving trucks over the next decade.

8. Environmental Trends (Going Green)

Environmental trends are changing the landscape of c-stores. Plastic straws and disposable cups have been marked as ecological hazards. The industry needs to work together on finding alternatives to risk not losing its customer base. California has issued a ban on new gasoline cars by 2035 which puts an emphasis on developing battery powered vehicles and the need for c-stores to add charging stations.

9. COVID-19 Impact

COVID-19 has caused a substantial decline in travel and gas consumption. C-stores have to expand marketing to draw traffic for food and other items beyond fuel.

Beyond 2021, operators need to monitor competition from nontraditional c-store locations and sources. Amazon and Dollar General are both evaluating c-store options. Operators have also expressed concern in recruiting top talent and having to explore nontraditional labor pools. Additionally, significant changes in the automobile industry in the next 10 years will see autonomous vehicles, ride sharing programs and battery powered vehicles which will dramatically reduce the fuel supply provided by c-stores. C-stores provide approximately 80% of the fuel purchased in the U.S.

Sources: csnews.com, dol.gov, nacsonline.com, convenience.org

Article Dean Dorton

With the 2018 changes to Kentucky’s tax code, there are a few particularly noteworthy for manufacturers: (1) for income tax: conformity with the federal tax changes, and adoption of single sales factor apportionment for multi-state corporations; (2) for sales tax: the taxation of some repair and installation labor, and a narrowing of the exemption for energy in excess of three percent of cost of production; and (3) for property tax: the phase-in of a credit for taxes paid on inventories, and the exemption of custom software.

Income Tax

Kentucky conforms to a majority of the changes to the federal tax code set forth in the Tax Cuts and Jobs Act. This means that the domestic production activities deduction is no longer available. The primary exception to Kentucky’s conformity is the decoupling from the federal depreciation and expensing provisions. Additionally, Kentucky’s income tax rate was changed to a flat 5% rate, and the state adopted single sales factor apportionment.

Single sales factor apportionment applies to multi-state corporations doing business in Kentucky. Previously, multi-state corporations apportioned income to Kentucky using a three-factor (sales, property, and payroll) apportionment formula. Effective for the 2018 tax year, only the sales factor will be used for apportionment purposes. The three-factor formula was retained for providers of communications and multichannel video programming services (cable and satellite TV) and certain financial organizations.

Sales and Use Tax

Kentucky joined 21 states and the District of Columbia in taxing installation and repair labor. This change was made by adding installation and repair labor to the definition of “gross receipts”, which is the tax base for sales and use tax. Specifically, gross receipts includes: “the amount charged for labor or services rendered in installing or applying the tangible personal property, digital property, or service sold.” Three general rules can be drawn from the statutory change.

  1. There is no sales tax on installation or repair labor, unless there is a transfer of tangible property or digital property.
  2. If a manufacturer is involved, there is no sales tax on installation or repair labor if the machinery or equipment is (a) directly used in manufacturing, (b) the labor is separately stated on the invoice, and (c) the customer provides the installer/repairer with a resale certificate.
  3. There is no sales tax on installation or repair labor if the customer is exempt from tax under Section 501(c)(3) of the Internal Revenue Code and the exempt entity gives the installer/repairer an exemption certificate.

The exemption for machinery and equipment directly used in manufacturing described in Rule 2 is critical to manufacturers. Machinery or equipment that is “directly used” in manufacturing is located at and between (i) the place where the raw materials start into a “continuous, unbroken, integrated process”, and (ii) the place at which the finished product is packaged and ready for sale. The manufacturer should provide the installer/repairer with a resale certificate. In the absence of a resale certificate, the installer/repairer should collect and remit sales tax at the 6% rate.

Historically, Kentucky has permitted manufacturers to exempt from sales tax energy purchases in excess of three percent (3%) of their cost of production. Some entities bifurcated the purchase of their raw materials from their other cost of production to maximize the energy exemption. The change to Kentucky’s statute forecloses this planning opportunity by requiring raw materials to be included in the calculation of cost of production, regardless of what entity purchases the raw materials.

Property Tax

The General Assembly also adopted an inventory tax credit to be phased-in over the next four years. The credit is a non-refundable income tax or limited liability entity tax credit allowed for ad valorem taxes timely paid on business inventory. The phase-in is as follows: 2018 – 25% of tax paid; 2019 – 50% of tax paid; 2020 – 75% of tax paid; and 2021 and forward – 100% of tax paid. Additionally, the legislature enacted an exemption from property tax for custom software.

Article Dean Dorton

Here are the key risks and opportunities for 2019:

Attracting and Retaining a Quality Workforce

Productivity challenges exist when a manufacturer can’t retain a consistent workforce. Manufacturing companies today have a hard time finding employees who will show up and be on time for work and stick with their jobs. When it’s hard to find reliable personnel, employers have to spend excess time hiring and training new employees, then rehiring and training new employees. While manufacturing firms are doing what they can to inspire a new generation of manufacturing employees and experts, there is still a considerable void when it comes to skills and experience. Manufacturers need to work with schools and universities in their communities to ensure that manufacturing focused subjects are being well promoted and taught. In addition, manufacturers need to bridge the gap by encouraging their older employees to gradually slow down to retirement, passing on valuable skills to younger employees during a transition phase.  Manufactures need to prepare for a wave of retirements in the next 10 years.

Cybersecurity

Manufacturers need to be proactive in cybersecurity by implementing effective controls to prevent and detect cyber-crime. Education of employees of potential phishing schemes is paramount to a successful cybersecurity campaign. Potential effects of a network infiltration include shut down of operations, theft of sensitive customer information, or theft of sensitive banking information.

Big Data Management and IT Infrastructure

Manufacturing involves a great deal of data and reliance on IT systems. Many companies are unsure of how to access and use that data to leverage positioning within a competitive market. In order for manufacturers to leverage their data properly, they must study data management opportunities and challenges, identify data management abilities, and prioritize data analysis plans. Additionally, manufacturers need to do an IT assessment to determine if investments need to be made to advance the company through more effective systems that facilitate data analysis. Additionally, controls need to be established around the use of artificial intelligence.

Product Development and Innovation

All manufacturers are cost conscious but should not miss out on well supported R&D opportunities. The global marketplace puts an emphasis on product development and innovation. Focus is needed to manage the innovation process and allow for a good flow of new product ideas and innovations to enhance future success.

Regulation Compliance and Traceability

The manufacturing sector faces increasing regulation and compliance measures. Inconsistent regulations from state to state and country to country present competitive challenges. Manufacturers must have complete visibility throughout their supply chain for their own compliance and that of their suppliers. Compliance can include everything from product safety to IT security to fair competition.  Revenue and lease accounting standards are changing and impacting manufactures’ financial statements in 2018-2020 as well.  Identifying a complete population of all leases under the new standard presents significant challenges to all businesses.

Safety, Including Overtime Management

Safety is a major concern for manufacturers as their employees routinely work around heavy equipment. Poor equipment maintenance can cause health and safety issues, as well as cause unplanned or excessive downtime. Manufacturers need to perform preventive maintenance on recommended schedules to keep operating costs low and throughput high while helping to ensure worker safety. Additionally, the monitoring of overtime hours to help protect the safety of employees represents an important oversight role and a vital way to control costs.

Embracing the Tax Cuts and Jobs Act

American manufactures should benefit from lower income tax rates which afford manufactures the opportunity to invest back into their businesses.  Owners may also look at stock buyback opportunities.  The new tax act allows for 100% bonus depreciation for five years which encourages capital investment.  Manufactures may be able to improve employee benefit packages as well to help retain key employees.  Lastly, manufactures should look to move business back to the U.S. from foreign locations to take advantage of the better tax landscape.

Robotics and Automation

(International Federation of Robotics; Robotic Industries Association)
Advancements in technology have afforded manufactures new tools that will alleviate some of the labor challenges.  Manufactures have begun to use autonomous vehicles in warehouses to move materials and product.  The nation is facing a shortage of truck drivers so the opportunity to use autonomous trucks could be accelerated as well.  Robot orders indicate high interest in the automobile industry, electrical/electronics industry and metals industry.  Experts proclaim that robots will change the economics of manufacturing with less time focused on low cost labor positions.  Robots are becoming lighter and less expansive which increases the potential applications.  Robots also offer the opportunity to be repurposed for multiple tasks.  The average global robot density is about 74 industrial robots installed per 10,000 employees in the manufacturing industry in 2016.  The most automated countries in the world are Republic of Korea, Singapore, Germany and Japan.  Smarter robots with a “brain” in the cloud as a basis will benefit from big data and collective learning.  Robots improve the quality of work by taking on dangerous, tedious and dirty jobs that are not possible or safe for humans to perform.  By 2020 it is estimated that approximately 3 million robots will be operational on a global basis.  In 2010 only 1 million robots were operational.  Global sales of industrial robots reached a record 387,000 units in 2017 (31% increase).  China saw the largest increase at 58% while USA increased 6%.

Culture

The culture at the company may not embrace change which puts the manufacturer at a competitive disadvantage.  Additionally, the tone at the top needs to be positive and sensitive to conducting ethical business.

Tariffs

Significant tariffs have emerged during 2018 which impact imported materials including aluminum and steel.  Companies will need to work closely with its vendors to understand any expected cost increases and the possibility of having to look for alternative vendors due to pricing pressure or the viability of the existing vendor.  The expected cost increase will need to be negated by a focus on after sales service, improved focus on maintenance to keep equipment operating efficiently and enhanced service part management that integrates ERP systems with vendors.

Sources: International Federation of Robotics, Robotic Industries Association, National Association of Manufacturers Outlook Survey