Understanding a company’s operating results is an important factor for a business owner to determine the value of a business. However, the operating results must be placed in the proper context by comparing them to results of the industry as a whole. By doing so, a business owner is able to understand how they are doing financially relative to their industry peers. This exercise is known as benchmarking.
Benchmarking provides business owners with the ability to compare various performance measures against companies of similar size within an industry. Through proper comparison, a company can point out its operating strengths and weaknesses, assess management effectiveness, and identify areas where it is outperforming or underperforming the industry.
Financial ratios are classified into five major categories that highlight a company’s liquidity, efficiency, financial leverage, profitability, and value. Some of the more useful financial benchmarks include, but are not limited to, the following:
- Sales and Profitability Trends
- Gross, Operating, and Net Profit Margins
- Inventory, Accounts Receivable, and Accounts Payable Turnover
- Salary and Compensation Data
- Current Ratio and Quick Ratio
- Debt Coverage Ratios
- Price to Earnings Ratio
When a business owner looks to improve the value of a business, benchmarking is fundamental to the process of continuous improvement. While improvements occur incrementally, the metrics need to be monitored, analyzed, and recalibrated periodically.
The following steps should be taken in order to ensure proper benchmarking:
- Determine what is critical for the company’s success.
- Identify metrics that measure the critical factors.
- Identify appropriate benchmarking data.
- Measure the company’s performance.
- Compare the company’s performance to the benchmark.
- Create and implement an action plan to achieve the desired benchmark.
- Review the process on a continuous basis.
Overall, benchmarking provides a credible reference point and helps analyze the areas within a company that need improvement. Through proper benchmarking, a company can drastically improve its operations and cash flow, which ultimately enhances value.