Benchmarking is the process of comparing your company’s financial performance against its historical performance, against industry standards and against top industry performers. Additionally, companies can benchmark performance against top performers in other industries that share similar operational characteristics. Doing so can not only help your company align its business goals with its operational process but also provide you with a road map to uncovering continuous performance improvement opportunities.
Performing financial benchmarking is not a difficult task, as long as you’re able to gather reliable financial data on a consistent basis. One of the key elements of benchmarking is seeing the trends and improvements in your company’s financial ratios over time once the data is plotted in a graph. This can help provide a reasonable prediction of future performance.
By identifying these trends, companies engaged in benchmarking can also detect any underlying problems with their performance or operations. For example, you can examine the days of payments in accounts receivable, which indicates the number of days a company takes to collect outstanding payments. A low number means a relatively fast collection and thus greater liquidity, while a higher number would indicate constrained cash flow and a need to borrow to satisfy obligations as they become due. Furthermore, a higher number may be indicative of staff shortage, performance issues, inefficient billing processes or communication issues between the billing department and operations. In a case such as this, an investigation of the system controls and operational processes related to the identified issue may yield possible solutions.
Let’s assume you’re the owner of a $50 million construction company and your goal is to either increase profitability while sustaining the current size of the company or increase revenue in the next five years to gain market share. What would be your plan to achieve these goals? What should your company’s balance sheet look like in order to successfully compete in the market and fulfill the proper surety requirement? A starting point should be comparing your company’s performance to the industry standard and top performers. Here’s how that might look:
• Increase Profitability - Profitability can be measured by your return on equity (ROE) and gross profit as percentage of revenues. If upper quartile performers in your trade generate $0.46 in profit for every $1 in net assets employed, then the ROE is 46 percent—a specific target for you to try to achieve by means such as identifying and reducing any inefficient use of net assets from your operations. Further benchmarking may include your revenues-to-net-fixed-assets and depreciation-expense-to-revenues ratios. A lower ratio of the former and a higher ratio of the latter may be indicative of under-utilized fixed assets, resulting in excess inventory and the additional costs arising out of such an excess. Regardless of the inefficiency uncovered, benchmarking can be the first step to identifying problems and improving profitability.
• Increase Revenue - A revenue growth plan can be daunting, and it requires significant planning. During the process, you may look to the industry statistics of best-in-class performers who generate twice as much revenue as you. In doing so, you have the opportunity to identify practices—financial or otherwise—that allow you to grow your company’s revenue.
Along with allowing companies to improve the monitoring of their current performance, benchmarking can also serve as a tool to prepare for change in the future. Such a benefit would arise specifically when market conditions change and lenders and sureties increase scrutiny of your financial well-being and performance. If these lenders and sureties begin to impose tougher financial covenants, companies that have been engaging in benchmarking—actively analyzing their financial performance and how changes in various practices affect ratios—will be prepared to adapt to new requirements much quicker than their competitors.
Benchmarking is a powerful tool when consistently used for a long period of time to discover how your company compares to others, to determine the trajectory of its performance and to identify possible areas of improvement. However, real improvements will come only after making thoughtful business decisions based on a careful analysis of the available data.