Why You Should Be Benchmarking
If you are a business owner, an accountant or business coach advising a growing business, measuring the company’s performance can help improve productivity and profit. Measuring performance keeps track of the business’s progress and gives you information to implement a target-setting system allowing you to strategize a plan for growth.
Benchmarking a business is the process of evaluating it and comparing it to other businesses or internally based on measurements. It’s a great tool for improving your understanding of a company’s performance and potential.
Who You Should Benchmark Against
You can benchmark internally within the business. For instance, you can examine performance among departments within the company.
Or you can compare the business to other businesses in the same industry. Yours or client’s company’s objectives and market position will also play a role in the comparisons you’d like to make.
Info Entrepreneurs, a team of business information experts from the Board of Trade of Metropolitan Montreal says, “For example, a small business in a crowded sector may want to benchmark itself against average performance levels in the sector. But a business targeting rapid and significant growth may choose comparisons with an established market leader.”
Different industries and companies within an industry measure success differently. But, these financial measurements or benchmarks provide a quick evaluation of a business’s financial health:
Net Profit Margin – This is the most important measurement. It is calculated by dividing net profit by revenue. By using this, you can understand how each dollar earned by the company is translated into profits.
Liquidity Ratios – You should review two liquidity ratios:
- Current Ratio: Divide current assets by current liabilities. The measurement shows the company’s cash amount, and also includes inventory in the calculation. Although, by including this, it could provide a distorted understanding of a company’s very short-term cash flow.
- Quick Ratio: This is the business’s amount of cash plus accounts receivable divided by current liabilities. This provides you a short-term view of the cash situation.
- Inventory days – Divide inventory by cost of goods sold, multiplied by 365 days, which measures the number of days it takes for the business to sell off inventory. You’ll want a low number here.
- Accounts receivable (AR) days – Divide accounts receivable by sales and multiply by 365 days. You’ll see an estimated number of days the company takes to turn accounts receivable into cash. Look for numbers on the lower end since it’s better to have cash in the bank than extra receivables in the business.
- Accounts payable (AP) days – Divide accounts payable by cost of goods sold and multiply by 365 days. This shows how quickly a business is paying its own vendors. Look for higher numbers because it signifies the business has the ability to hold onto cash longer.
- Make sure all data is accurate that you are using in your calculations.
- Businesses run in real time and finances shift over the course of a year. Use the most current data you can.
- You need relevant data. Geographic regions, industries, and business sizes affect benchmarking data. To have effective data, all of these characteristics need to match your company’s characteristics.
Once you have generated benchmarking analysis, now you can use it to improve your business by setting targets to help you reach the benchmark values you wish to be at!