Benchmarking: Part 2

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.

By the Lights on the Dashboard

Your vehicle’s dashboard can provide you with important information such as speed, distance traveled, engine status, etc. However, without the proper amount of light and information, you would not be able to see, process and understand the information provided by your dashboard.

The same could be said for your business’s dashboard. This dashboard tells you what’s happening in your business, and brings your attention to any warning lights or indicators that might pop up. Business dashboards can be in print form or electronic (which is usually the way to go), and your team of accountants can help you set it up (yeah, we’re nice like that). As long as you have a dashboard that tells you vital information about your business, the format isn’t too big of an issue.

It’s also important to keep in mind dashboards are not one-size-fits-all. In fact, another business’s dashboard might look similar to or even fancier than yours – but it simply won’t help you run your business. The key to having a useful dashboard isn’t the amount of information it provides, but rather the accuracy and relevancy of the information. Having a dashboard that specifically fits your business can allow you to make smarter, quicker decisions.

So what should your dashboard contain?

Your business’s dashboard should contain key performance indicators (KPIs), ratios, metrics, and other pertinent information that can help you make smart business decisions. In a nutshell, your dashboard should be able to quickly provide you with insight into your business.

The metrics your dashboard displays are not randomly chosen; rather, they are specifically selected to give you a better understanding of your business. The metrics you choose to monitor on your dashboard should be able to help you decide if your business is performing the mission and vision set for it. To choose which metrics to measure, it can be helpful to create a strategic map. Similar to a regular map, this map can help you see where your business is, where you want your business to go and what it will take to get there.

Business dashboards are typically broken down into four areas: client, internal processes, financials and learning and growing. Each area should contain at least three, but no more than four, metrics. If you select the correct three to four metrics (no worries, your accountants and advisors can help with this), you should have enough information to make effective management decisions. If you have more than four, you increase the risk of having too much information to sort through – you want things to be as straightforward as possible.

After all, the goal of having a dashboard is to make decision making quicker and easier. However, it’s important to remember even though having a dashboard gives you a quick look at key metrics, it shouldn’t replace your regular financial reviews and planning.

A dashboard can be a helpful tool to keep your business on track and aiming for success. Using it on a regular basis can help you monitor your business and make important decisions without having to take excessive amounts of time out of your already busy schedule.

Seem like a lot of work? We can help you set up a dashboard to keep your business on track. Seriously, just ask.

 

Benchmarking 103: Pitfalls to Avoid

While we think you really should be benchmarking (come on, how else will you know how you rate?), we also feel the obligation to tell you about some things to avoid when starting a benchmarking analysis. We’re nice like that.

  • Comparing Company A to Company B: Comparing your business to a peer group is helpful if the peer group is representative of the industry. However, if you begin to compare yourself to another, single company, there may be considerable differences that prevent true comparisons. Look critically at any benchmark analysis that restricts the sample size to only one other company.
  • Be careful with calculations and conclusions drawn from them: certain benchmarks (net profit margin, liquidity ratios, and turnover ratios) are common financial measurements, and their calculations are not generally refuted or changed. However, if you expand your benchmark analysis to include industry-specific key performance indicators (KPIs) (restaurant-sales per seat, for example), be sure to use the same calculation, period after period. If a subaccount is included for one period but then excluded for the next period, any trend analysis performed could be misleading.
    • Once definitions for the metrics are determined, be sure that all members of management and the finance team have this set of definitions. Also, be sure they understand what the metrics mean. There should only be one interpretation.
  • Assume that numbers and performance are always changing: Positions in a horse race are constantly shifting: first to third, fourth to last and so on. Comparing your business to its peers only once per year may not be optimal, given that the industry is always changing, even if your business isn’t. The more frequent the benchmark analysis is performed, the sooner the business can identify trends and react.
  • Recognize that the benchmark analysis doesn’t end with a variance report: Though it may seem that the work is complete once you have compiled a report showing variances between its financial metrics and its peer group benchmarks, the work is actually just beginning. And so are the opportunities! Each variance gives you a potential problem area to fix and the opportunity to improve the company’s overall performance. The variance report will show in which areas the business is really excelling. Take pride in these success, and see if the winning strategy can be implemented in other areas of the company.

Remember: the objective of benchmarking analysis isn’t to build a benchmark report. The objective is to illuminate successes and challenges for the company and give business owners actionable insights!