Benchmarking. Another one of those buzzwords. If I used benchmarking, would it help my business be more profitable? What you should be asking is “if I did benchmarking more often and more accurately, could it improve my businesses profitability?” The fact is you are already benchmarking.
When you look at last month’s or last year’s financial statements and compare them to this year’s, you are benchmarking, which is simply comparing your results to another set of results to gain useful information. The goal is to use that new information to make better business decisions. When “benchmarking” is used as a buzzword in business, it often means comparing your financial results to those of similar businesses or competitors. Often what is gained from this type of comparison is information about your businesses strengths and weaknesses.
Benchmarking against other companies is very useful, but the best place to start benchmarking is with your own company’s historical data. Using your own historical data allows quicker identification of accuracy issues as well as illustrates some risks and pitfalls of benchmarking.
The most important aspect in benchmarking is the accuracy of your financial data. Another aspect of benchmarking closely related to accuracy is comparability. The easiest way to explain comparability is the “apples-to-apples” standard. If you are going to gain useful information from a comparison of data, you want both sets of data to be measuring the same thing.
Consider the following examples of the importance of accuracy and comparability:
- You are comparing gross sales amounts of your rainbow colored widgets for 2010 with last year’s sales.
- Last year, your invoices only showed total sales and not sales by product type.
- You want to compare the cost of goods sold for “tacos” this year vs. last year.
- Last year, you often purchased raw materials at Costco with a credit card.
- You only reconciled your checking account last year. The credit card account was not reconciled, and the credit card payment was entered as a lump sum and not as individual charges for goods. You don’t remember to what expense account the credit card payment was coded.
- Through an industry trade association, you have found cost of goods percentages for similar-sized businesses who manufacture the same product as yours.
- Your costs are significantly higher.
- Are you inefficient? Do you need wholesale changes to your processes?
- Maybe by reading this blog you have begun to better “job-cost” your product. Your cost-of-goods percentage includes rent, overhead and production support staff. The comparison data only includes raw materials and labor.
Banks are big users of benchmarking, a great risk analysis tool. Ratios are a form of benchmarking. The computation of a ratio (such as times interest earned or current ratio) and its comparison to industry averages or historical data is used by banks to determine your creditworthiness. Have you ever wondered why some loans from banks require periodic reviewed or audited financial statements? Reviewed and audited financial statements give banks more assurance about the comparability (apples-to-apples) of the financial statements and the categorization of assets, liabilities, equity, revenue and expenses. Financial statements reviewed or audited by an CPA are more comparable than those provided by the client. The more accurate the comparability, the more accurate the ratios and the better the risk analysis.
So one way you can become more profitable is by having accurate financial statements that show how strong your company really is. This allows you to get bank financing at a reasonable rate, and you use the funding to buy new equipment or pay down that high-interest credit card.
Benchmarking is a topic we will address again in the future, but remember, you are already doing it.
Buzzwords- Is a blog post category devoted to explaining some trendy words and techniques you might hear in management or finance.