Why Financial Benchmarking Really Matters
It's for the good of the business.
Posted by firstname.lastname@example.org on February 10, 2020
What do we mean by financial benchmarking?
The term “benchmarking” in itself is broad, and in a business context can pretty much be applied to any quantifiable process or operation. It’s typically an ongoing practice that companies can use for continuous improvement purposes.
Financial benchmarking in particular involves running analyses of financial performances and comparing the results. It’s a sure-shot way for assessing a company's overall competitiveness, efficiency and productivity, which is especially useful if you’re operating a dog-eat-dog industry.
In practice, the information gathered from financial benchmarking is used to improve business processes, become cost-efficient, and enhance productivity.
How does it work?
Put simply, benchmarking is usually used to evaluate the performance of a business by focusing on one or more particular indicators (we’ll cover these indicators further down), and it’s often put in place and managed by strategic management or divisional heads.
It works like this - companies evaluate the various aspects of their processes and compare them to the processes of “best practice” companies. Most often these “best practice” companies are from within the same field or industry. From there the information allows new and better strategies to be formulated, which all works towards making improvements or adopting new best practices.
Useful financial benchmarks involve:
- Gross, operating, and net profit margins
- Cost per employee
- Revenue per employee
- Sales and profitability trends
- Inventory and accounts receivable turnover
- Salary and compensation data
- Marketing expense as a percent of revenue
- Revenue to fixed assets ratio
Let’s take a look at the below. What we’re seeing here is a graph showing the average number of days specific industries in the US take to complete their Accounts Payable invoice cycle:
Source: SSON Analytics
Let’s say you’re the Head of Finance & Accounting for a top-dog utilities organisation in North America, and your average AP Invoice cycle time is 16 days.
Though you might consider yourself to be a key player in the industry and be confident in your service delivery, straight away you can deduce that you’re falling below average within your industry. It’s as simple as that, and ultimately means there’s improvements that must be made.
Let’s look at another example:
Source: SSON Analytics
The chart above shows how ‘data-ready’ finance departments in Middle Eastern organisations are to support real-time reporting and advanced analytics.
Another role play - you’re the Group Head of Financial Reporting in a Dubai-based firm. Your company has ambitious goals, aggressive yearly targets and aspirations to be the key player in your industry.
However, you know for a fact that as a business you’re still overcoming issues with siloed and unstandardised data, and this is holding you back from being fully ‘data-ready’.
Even though you sit with the masses, you now know that 32% of other Middle Eastern companies are already there. They’re ready. And you’re not quite there yet. For a company that’s as ambitious as your’s, that’s probably going to stir things up a bit.
Why is it so important to know where you stand?
Short answer? So you know where you stand.
Longer answer? With benchmarking-based goals, you take away the possibility of setting targets that are too high or too low. When you perform financial benchmarking against your competitors, you can measure their performance using specific metrics, and this allows you to devise robust strategies and set realistic goals.
Financial benchmarking not only serves as a performance metric, but it also shines a light into those dark corners and magnifies small issues that need correcting before they start snowballing.
For example, the most typical measures of business success are revenue and profitability, but the stories they both tell can be so drastically different. For example, you and a competitor could bring in the same revenue, and since revenue is arguably the leading indicator of business success you might think that you’re are on a level playing field. But when you look at your gross profit margins, you realise that your gross profit margin is 3% less.
For every $1 million in revenue, they have a $30,000 advantage. That's a number not to be ignored.
Once you discover discrepancies, you can better understand your strengths and weaknesses, as well as those of your competitors. You will be positioned to identify opportunities for change.
What’s more, the business processes and systems within your finance function are inextricably linked with other enterprise functions. Process improvements in one area may have a ripple effect on others; for example, improved IT controls may result in more reliable data for decision-making in finance. That’s something you can thank your trusty IT team for.
Financial benchmarking can help your business to set realistic financial goals. Some business owners like setting goals that are too high and risky, which eventually hurts their business when unfulfilled, and end up setting low targets which can be achieved quickly but means they’ll be still underperforming. Therefore, to outgrow in this ever-growing market, setting financial-benchmarking dependant goals is an ideal solution.
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