How to Enhance Your Business with Benchmarking Analysis

Why Your Business Should Use Benchmarking

Benchmarking involves evaluating your business and comparing it either internally or against other businesses using specific metrics. It’s a powerful tool to help you better understand your company’s performance and uncover its potential for improvement.

Who to Benchmark Against

You can perform internal benchmarking by comparing different departments within your company. Alternatively, you can compare your business to others in the same industry. The objectives and market position of your or your client’s company will also influence the comparisons you choose to make.

For example, iCFO, a leading provider of financial consulting services, advises that small businesses in crowded sectors might choose to benchmark against average performance levels within the sector. In contrast, a company aiming for rapid growth may prefer to compare itself with established market leaders.

What to Measure

Different industries and companies have various ways of measuring success. However, the following financial metrics are commonly used to quickly assess a business’s financial health:

Net Profit Margin: This is the most critical metric, calculated by dividing net profit by revenue. It helps you understand how much of each dollar earned is converted into profit.

Liquidity Ratios: There are two key liquidity ratios to consider:

• Current Ratio: Divide current assets by current liabilities. This metric indicates the company’s cash availability, including inventory, though including inventory might distort the understanding of short-term cash flow.
• Quick Ratio: This is calculated by dividing cash plus accounts receivable by current liabilities, giving a more immediate view of the business’s cash situation.

Turnover Ratios:

• Inventory Days: Divide inventory by the cost of goods sold and multiply by 365 days. This measures how many days it takes to sell off inventory. A lower number is preferable.
• Accounts Receivable (AR) Days: Divide accounts receivable by sales and multiply by 365 days to estimate how long it takes to convert receivables into cash. Lower numbers are ideal since it’s better to have cash on hand than outstanding receivables.
• Accounts Payable (AP) Days: Divide accounts payable by the cost of goods sold and multiply by 365 days. This shows how quickly the business pays its vendors. Higher numbers indicate that the business can hold onto its cash longer.

Important Considerations

• Ensure the data you use is accurate.
• Since businesses operate in real-time and finances fluctuate throughout the year, use the most current data available.
• Data relevance is key. Geographic location, industry, and business size all impact benchmarking data, so make sure these factors align with your company’s characteristics.

By integrating benchmarking into your business strategy, iCFO can help you set realistic goals and achieve sustainable growth.