Many business owners employ the strategy of benchmarking to
assess the health of their company. Benchmarks provide a frame of
reference by which they can gauge financial success and measure progress
against an established goal. Typically, an industry benchmark is a
range of financial performance metrics in key areas, compiled by
averaging data from a group of comparable businesses.
In today's economic climate, many small to mid-sized businesses may find it difficult to borrow money due to stricter financing controls, so it is even more important to ensure that a business is functioning as efficiently as possible, reinvesting profits to fund operations. Without use of an industry benchmark, businesses may think they are performing efficiently while in reality they have no basis for comparison. When evaluating benchmarks to assess progress, businesses should consider the following:
Source of data- One of the challenges in calculating benchmarks is the data source from which they are derived. Many small, privately held companies do not publish their financial data. Conversely, data such as tax filings for publicly held companies may be intentionally deflated or under reported for tax purposes.
Relevancy of data- When identifying comparable companies, businesses need to ensure that the companies are similar on multiple levels, as much as possible. For example, the comparable companies should offer similar products and/or services, have similar revenues, corporate structure, and number of employees.
Recency of data- When comparing a company's financial performance to an established benchmark, it is critical to understand the recency of the data comprising that benchmark. Financial figures from 5 years ago used to create a benchmark need to be noted, as economic conditions have changed substantially, and therefore the benchmark may be faulty.
Calculation Methodology- When developing benchmarks, it is also important to know how companies arrived at their calculations so that the financials are an "apples to apples" comparison. For example, one company within the comparables may define "profit" as earnings before income taxes while another may define it as earnings before income taxes, depreciation and amortization.
Key Metric Comparisons- There are several ratios that businesses use to assess financial performance which can be useful to benchmark. These include profit margin (measure of profitability), Quick Ratio (measures immediate cash liquidity, cash + accounts receivable/liabilities), Current Ratio (measures liquidity, current assets/current liabilities), Debt: Equity (measures how well a company is leveraging its debt).
Financial benchmarking can be an invaluable tool to small to mid-sized businesses in assessing how they compare with their peers. It is important to acknowledge that although is an important tool, the benchmarks are meant to exist as a guide in assessing how a business is trending more than an absolute measure of success.
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In today's economic climate, many small to mid-sized businesses may find it difficult to borrow money due to stricter financing controls, so it is even more important to ensure that a business is functioning as efficiently as possible, reinvesting profits to fund operations. Without use of an industry benchmark, businesses may think they are performing efficiently while in reality they have no basis for comparison. When evaluating benchmarks to assess progress, businesses should consider the following:
Source of data- One of the challenges in calculating benchmarks is the data source from which they are derived. Many small, privately held companies do not publish their financial data. Conversely, data such as tax filings for publicly held companies may be intentionally deflated or under reported for tax purposes.
Relevancy of data- When identifying comparable companies, businesses need to ensure that the companies are similar on multiple levels, as much as possible. For example, the comparable companies should offer similar products and/or services, have similar revenues, corporate structure, and number of employees.
Recency of data- When comparing a company's financial performance to an established benchmark, it is critical to understand the recency of the data comprising that benchmark. Financial figures from 5 years ago used to create a benchmark need to be noted, as economic conditions have changed substantially, and therefore the benchmark may be faulty.
Calculation Methodology- When developing benchmarks, it is also important to know how companies arrived at their calculations so that the financials are an "apples to apples" comparison. For example, one company within the comparables may define "profit" as earnings before income taxes while another may define it as earnings before income taxes, depreciation and amortization.
Key Metric Comparisons- There are several ratios that businesses use to assess financial performance which can be useful to benchmark. These include profit margin (measure of profitability), Quick Ratio (measures immediate cash liquidity, cash + accounts receivable/liabilities), Current Ratio (measures liquidity, current assets/current liabilities), Debt: Equity (measures how well a company is leveraging its debt).
Financial benchmarking can be an invaluable tool to small to mid-sized businesses in assessing how they compare with their peers. It is important to acknowledge that although is an important tool, the benchmarks are meant to exist as a guide in assessing how a business is trending more than an absolute measure of success.
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