Financial Benchmarks: Elevate Your Decisions With Data

What is financial benchmarking?

Financial benchmarking is one way to assess a business’s financial health. The process involves comparing key metrics in the company’s financials, such as profitability, liquidity or growth, against competitors or industry averages. These comparisons help you understand where a company is doing well and identify areas for improvement. Financial benchmarking can also offer guidance to business owners that want to improve their company’s finances to achieve stronger growth and greater success.

Whether you’re evaluating your own business, a client’s company or a competitor, financial benchmarking provides a clear picture of how a business measures up to other players in its industry. You can also use the information you gather to make decisions that maximize return on investment, evaluate merger or acquisition prospects, and identify potential risks and opportunities.

In short, benchmarking helps companies stay ahead of the curve to maximize their success.

What outcomes can you achieve with financial benchmarking?

Financial benchmarking provides a framework to assess a company’s performance against the competition. For the purposes of this article, we’ll run through the process of benchmarking your own company, but these steps can easily apply to those working in a consulting, advisory, auditing or lending capacity. It’s an essential process to help enhance or sustain business performance, and can help you:

1. Identify strengths and weaknesses

Financial benchmarking shines a spotlight on your company's performance, highlighting areas where it excels and those that require improvement. By comparing key financial metrics, you can identify what sets your business apart and where it may be falling short. This knowledge helps you decide on targeted actions to enhance your strengths and address weaknesses head-on, and is a key component of competitive analysis.

2. Optimize efficiency and profitability

Insights into industry best practices help uncover strategies that you can implement to optimize your operations and boost profitability. Financial benchmarking can help you identify innovative approaches that top-performing businesses use, allowing you to analyze and fine-tune your business processes and boost efficiency. This, in turn, helps your business becomes a well-oiled machine, benefitting your bottom line.

3. Allocate resources strategically

Even the largest companies have finite resources, and making sure they’re allocated in the right places is key. Financial benchmarking empowers you to understand how your performance measures up against industry standards, so you can identify areas where investment would yield the greatest returns. Strategic allocation of resources propels your growth and offers your business a competitive edge in the marketplace.

4. Mitigate risks and adapt to market changes

Benchmarking allows you to analyze potential risks and market changes early on, so you can adapt your strategies proactively and stay ahead of the game. Comparing your performance with industry peers enables you to observe market trends and adjust your operations accordingly. This foresight can help you respond to evolving industry dynamics and mitigate potential threats by putting robust risk management frameworks in place.

5. Enhance decision-making

Quantifiable data empowers you to make informed decisions. Whether you need to evaluate potential partnerships, assess merger opportunities or identify risks, financial benchmarking equips you with the insights and evidence you need to navigate the ever-changing business landscape with confidence.

Key methods for financial benchmarking

Now that we’ve broken down what financial benchmarking is and why it’s important, let’s look at some methods for comparing your performance against an industry or sector average, or even a specific competitor.

Analyzing Cost Structure

Analyzing cost structures is the process of evaluating and comparing your business’s spending with that of a competitor or an industry or sector average. Cost structure analysis highlights areas to improve efficiency and reduce expenses. This involves examining direct costs, such as raw materials and labor, and indirect costs, such as overhead expenses, as well as how those expenses are trending over time. Identifying areas where your company’s spending is not in line with the industry average or direction can provide insights into the different processes or strategies used in the industry. For example, growth in industry average overhead costs may indicate that your competitors are investing in tools and automation. Cost structure analysis can help you identify such discrepancies, and can be part of a wider analysis using a framework like Porter’s Five Forces.

Assessing Financial Ratios

Financial ratios are essential indicators that provide insight into a company's financial health. These include:

• Liquidity ratios, such as the current ratio and quick ratio, which assess a company's ability to meet short-term obligations
• Coverage ratios, such as interest coverage ratio and times interest earned, which determine a company's ability to pay its debts
• Leverage ratios, such as debt-to-equity ratio and debt-to-asset ratio, which measure a company's debt levels and financial risk
• Profitability ratios, such as gross profit margin and return on assets, which help gauge the effectiveness of a company's operations and management
• Operating ratios, such as inventory turnover and accounts receivable turnover, which measure the efficiency of a company's day-to-day operations.

By comparing these ratios with industry peers, you can identify areas where your business excels or falls short, and make data-driven decisions to improve performance.

Examining Key Ratios

Key ratios offer you an in-depth understanding of how your company's performance metrics relate to one another, and how they measure up to your competitors’ performance. Some common key ratios include net profit margin, which is the percentage of revenue left after accounting for all expenses; revenue per employee, which is the amount of revenue your company generates for each person it employs; and wages as a share of revenue, which is the percentage of a company or industry’s revenue that is spent on employee wages. These ratios are useful when comparing your business to others of a similar size within your industry, and can help to identify bloat or underperformance due to inefficient use of resources. Comparing these ratios against broader industry benchmarks allows you to gain a clearer picture of your competitive position and identify areas for improvement.

The Financial Benchmarking Process Explained

The financial benchmarking process consists of several key steps that enable businesses to effectively analyze performance and draw valuable insights. Let’s break down the process.

1. Define objectives

The first step in the financial benchmarking process is to clearly define the objectives and goals of the analysis. This helps you focus on the most critical areas of your business’s operations and ensure the benchmarking exercise yields actionable insights.

2. Identify Key Performance Indicators (KPIs)

Next, select the relevant KPIs to measure your business’s performance against industry standards and competitors. These KPIs can include financial metrics such as revenue, profit margin and return on investment (ROI), and operational metrics such as productivity, efficiency and customer satisfaction.

3. Collect data

After you’ve identified the KPIs, you need to collect accurate data, both internally and externally. Internal data comes from your company's financial records and systems, while external data is typically sourced from industry reports, surveys, and other research materials. Make sure that the external data you source is credible and up-to-date to ensure that your insights are meaningful and reliable.

4. Analyze data

With the required data in hand, conduct a thorough analysis to compare your business’s performance against industry benchmarks and competitors. This involves calculating relevant ratios, identifying trends, and determining areas where your company excels or lags behind its peers.

5. Develop an action plan

Based on the insights gained from the data analysis, develop an action plan to address any identified weaknesses and capitalize on your strengths. This plan should outline the specific steps and resources required to achieve the desired improvements. Make sure you return to the plan regularly to assess your progress.

6. Keep improving!

Financial benchmarking shouldn’t be a one-time exercise. Instead, it should be integrated into your company's ongoing strategic planning and performance management processes. Regularly updating benchmarks and conducting comparisons allows you to be proactive and continuously refine strategies, ensuring sustained success and competitiveness in the market.

Financial benchmarking in action

We can see that financial benchmarking is an extremely valuable tool for businesses of all sizes, so it’s worth looking at an example of financial benchmarking in use.

Picture a growing software development company that wants to take their industry by storm. They have a solid understanding of their Total Addressable Market, but they’re ready to dig a bit deeper. They decide to use financial benchmarking to figure out how they measure up to the competition and identify ways to improve.

First, they set their sights on improving profitability, increasing market share, and optimizing operations. To get there, they look at key performance indicators (KPIs) like revenue growth, net profit margin, return on equity, and employee productivity. They gather data from their records and industry reports to see how they stack up against the competition.

After crunching the numbers, they find out they're doing well in some areas. Their net profit margin and employee productivity are above average, which is great news. But their revenue growth and return on equity could use a boost.

So, they get to work. They invest in sales and marketing to drive revenue growth, and they tighten up their financial strategy to increase their return on equity. They keep tabs on their progress by updating their benchmarks and analyzing their finances regularly.

Using financial benchmarking, this software development company has analyzed where they stand and developed strategies to help them succeed.