It is not, has not and likely will not be “business as usual” as we might have considered the phrase in the years leading up to the recession. Business as usual now includes continual improvement, being a student of your business and learning how to do it better, faster and with less. St
rategically, we need to be better businesspeople more than ever before. One way to do this is by benchmarking.
The dictionary defines benchmarking as “something that serves as a standard by which others may be measured or judged.” In simple terms, it starts with comparing your business performance metrics against the industry best. The comparison is the starting point for an in-depth review of your business processes in order to move your metrics toward the industry best.
There are numerous reasons to consider benchmarking, including:
Competition. A business may have trimmed overhead by 10 percent and now sits at 25 percent. A 10 percent reduction is great, but if the competition is at 20 percent, you may not be competitive.
Customer satisfaction. How do your customers stack you up against your competitors? Understanding this can help you identify key areas to improve.
Motivation and focus. Comparing your current performance against that of the best in the industry gives you a clearer set of goals to strive toward.
Benchmarking applies to both business operations and finances. For instance, an operational benchmark might be that you produce 10 widgets per day, whereas a key financial benchmark is return on equity. Operational and financial benchmarks go hand in hand. In fact, most financial benchmarks result from operational decisions and whether the goals or benchmarks are achieved.
Operational benchmarks vary from industry to industry, whereas financial benchmarks tend to cross industry lines. The remainder of this article discusses the financial benchmarks, or key performance indicators (KPIs), which are important to outside parties such as banks and sureties.
While they vary for each industry, there are typically three categories of ratios that measure financial health and performance. The three categories broadly measured are liquidity, operational results and leverage. In this market, your financial health is being looked at more than ever by creditors, banks, customers, governmental agencies and insurance companies, to name a few.
Take the construction industry as an example for a look at some of these ratios to see how banks and sureties are benchmarking contractors. It’s important for the contractor, banks and sureties to understand what the KPIs reveal and whether results are short-term or long-term. Financial benchmarking involves comparing your construction company’s KPIs with those of a best-in-class peer group.
• Current ratio: Current assets divided by current liabilities. The extent to which current assets are available to satisfy current liabilities. Minimum acceptable is usually 1.2, with best in class higher.
• Working capital turnover ratio: Revenue divided by (current assets minus current liabilities). The amount of revenue being supported by each dollar of net working capital employed. Generally averages 10 to 15 times with best in class higher. But a very high ratio may indicate a lack of sufficient working capital, which is not good.
• Return on assets ratio: Net earnings before income taxes divided by total assets. The profit generated by the total assets employed. A higher ratio reflects a more effective employment of company assets. Generally averages from 7 to 12 percent, with best in class higher.
• Return on equity: Net earnings before income tax divided by total net worth. The profits generated by net assets employed. Reflects stockholder return on investment. Generally a higher ratio indicates a more profitable company.
• Debt to equity ratio: Total liabilities divided by total net worth. The relationship between creditors and owners. Generally, a ratio of 2.5 or lower is considered acceptable.
Where to begin?
Industry trade associations are often a good source of KPIs. For instance, the Construction Financial Management Association publishes its Construction Industry Financial Analysis each year. As a supplement to that, Moss Adams LLP surveys West Coast construction companies and compiles financial information to provide a benchmarking tool, which we also publish annually.
Whatever your industry, benchmarking, used appropriately, can be an effective tool in improving your business and financial operations.
Glenn Wattum provides expertise on a wide range of tax matters to businesses in the construction and real estate industries. He can be reached at 425-303-3022 or glenn.wattum@mossadams.com.
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