Benchmarking your business to see how it stacks up against industry competitors helps you learn about your company and where operations can be improved.
“If you focus on just sales or profits, you miss other variables and expenses that, with some tweaking, can make a substantial difference in your profit and cash flow,” says Dave Cain, vice president of operations at Rea & Associates.
Smart Business spoke with Cain about the benchmarking process and how to utilize the data that is produced.
Can the benchmarking process be applied to any business in any industry?
Benchmarking compares you to your industry. I’m not aware of any industry where it wouldn’t work — one service we use has a database of 10,000 different entity types that can be used for comparisons. Dental, medical, construction and manufacturing all have some type of benchmarking tools. Software programs are available that allow you to find real-time data and develop benchmarks based on immediate industry information rather than information that might have been accumulated a year ago.
What data should be benchmarked?
Net profit margin and liquidity ratios are two general ones that can be used for any business. If you’re in manufacturing or retail and have accounts receivable, one good benchmark is turnover ratio — how quickly do you collect receivables in comparison to other businesses of the same type?
Industry comparisons have substantial value because you can understand what’s going on in the industry and improve your company’s performance. For example, a manufacturer of plastic bags would be able to find information specifically about plastic bag manufacturers, not just the plastics industry as a whole. If that manufacturer has a sales percentage of revenue ratio of 10 percent, compared to 15 percent elsewhere, it would be worth investigating why competitors can operate at a lower margin.
Who should be involved in the benchmarking process?
Involve your accountant, your internal accounting department and members of senior management. Determine what ratios and analysis are important to your business. If accounts receivable turnover ratio is an area of priority, the person in charge of accounts receivable should be included.
Companies can do benchmarking themselves, depending on the level of experience within the accounting staff and the resources available to them. However, it also takes expertise to determine how to use the information. That’s where a CPA can work with your accounting team and senior management to develop a strategic plan.
Do you need to decide in advance how the benchmarking information will be used?
Benchmarking results will dictate what actions you take. If your inventory cycles through every 90 days, you might think that’s good. But having inventory sitting for three months could be why you have no cash flow. If you find competitors collect receivables in 45 days, you would look at how you can cut down that period and improve cash flow.
The whole idea of benchmarking is to discover areas where you can make an impact. It’s learning about your business to determine best practices. So many businesses only look at sales and profits, which are the basic indicators, but there are always other areas to review. One client increased his revenue by $200,000 and kept focusing on that top line, but it cost him $225,000 in payroll to get that boost.
Is the process different with internal benchmarks?
Yes, because then you’re measuring against yourself to ensure consistency. Whether by department or location, you look at the revenue and expenses, as well as the contribution margin to the rest of the organization. Then those metrics are applied to outside data information to see how you compare against your industry.
Benchmarking is usually done at year-end, although you might do an interim report to analyze if adjustments you’ve made are having the desired impact on your business.
Benchmarking is really learning about your market and your business, and helping you determine best practices. ●
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