In our latest blog post, we looked at why benchmarking is important for your business. Some of those reasons include:
- It keeps you up to speed with real-time data (that is, as long as the data is timely, relevant, and accurate).
- It never goes out of style and can be used continually, rather than a one-and-done solution.
- It truly helps you understand the well-being of your business situation.
So now that we have a refresher of why benchmarking is great for your business, let’s dive in deeper. After you decide which data source you’ll use (make sure it’s accurate, timely and relevant), the challenge is now deciding which benchmarks to analyze and use as a tool for the success of your business.
We’ve said it before, but we will mention it again. Different industries, and different companies within an industry, might have different success measures. For example, a contractor might have large subcontractor expenditures. Are these expenses normal considering the contractor’s sales volume?
Instead of taking a look at industry-specific metrics, we’re going to focus on some metrics that are universally important and can provide a quick look into a company’s health.
- Liquidity Ratios. Yes plural – because there are two that need to be analyzed together. They are:
- Current Ratio which is shown as current assets divided by current liabilities. This metric shows general liquidity, but it does have some limitations. If inventory is included in calculating the current ratio, it might provide a distorted understanding of your cash flow.
- Quick Ratio is expressed as cash accounts receivable divided by current liabilities. This ratio might not be perfect for showing liquidity, but it can be a useful and popular comparison to pair with the current ratio.
- Net Profit Margin. Expressed as net-profit before taxes in a given period divided by sales. Another way to view this? How many cents of profit you extract from each dollar you earn in revenue. This might be a basic metric, but it’s extremely important!
- Turnover Ratios. There are three ratios that you should consider:
- Inventory Days which is shown as inventory divided by cost of goods sold, multiplied by 365 days. Inventory days tells the story of how long it takes to sell off inventory. However, it’s important to remember this ratio is very industry-specific. Imagine how long wine is stored in a winery compared to the length of time milk sits in a grocery store cooler. Usually, lower numbers are better.
- Accounts Payable Ratio is expressed as accounts payable divided by cost of goods sold, multiplied by 365 days. The accounts payable ratio shows the number of days you take to pay the vendors. Higher numbers are better – it means you hold on to cash longer.
- Accounts Receivable Ratio is shown as accounts receivable divided by sales, multiplied by 365 days. This is a rough measure of the number of days your company takes to turn accounts receivable to cash. You want lower numbers, as it is better to have cash in the bank than extra receivables on the books.
By paying attention to some of these important metrics, you can build a picture of where your business Is, where it should be going and what it will take to get there.