Preface: Comparing your financial data to industry benchmarks may confirm strengths your business has in its sector or locale, and reveal areas for improvements. This blog is about tracking your business pulse with financial industry information.
Business Health Checkup
Credit: Jake Dietz, CPA
Is your company healthy? This question could be hard to answer. Even if you know your financial numbers, ratios and percentages, how do you know if they are vibrant? Different industries and fields have their own sets of benchmarks, or standards for comparison. For example, a 30% gross profit margin might satisfy entrepreneurs in one industry, but it might disappoint entrepreneurs in a separate industry. How can an entrepreneur or manager know if a business’s numbers and percentages are good? Compare your numbers to industry benchmarks to reveal strengths and identify weaknesses and then work to improve necessary areas.
Comparing your data to benchmarks may confirm strengths your business has in its sector or area. For example, suppose the industry benchmark is 30% for selling, general, and administrative (SG&A) expenses, but your SG&A expenses are only 20%. That indicates you run a leaner, more efficient operation than your competitors. That strength may help you weather a downturn that could put some out of business.
When you see your data beside an industry benchmark, you might also see where your company is weaker. For example, suppose the industry benchmark for gross profit percentage is 30%, but your gross profit percentage is only 15%. Assuming your overhead is the same as the industry benchmark, then you need to sell much more just to make the same net profit percentage as the industry because your gross profit percentage is below the benchmark. A good time to call a financial physician? The company is not fulfilling its full potential, even if it manages to sell enough to be profitable. Good accounting is important in making these financial assessments.
Not only can benchmarks reveal weakness in profitability, but they can also reveal weakness in other areas, such as liquidity. Liquidity refers to a company’s capability of paying its liabilities in the short term. A company’s current ratio can be compared to the industry current ratio. A current ratio compares current assets (available within a year e.g. cash and accounts receivable or inventory) to current liabilities (payable within a year, e.g. accounts payable, accrued expenses or debt). If a company’s current ratio is much lower than the industry benchmark, then the company may struggle with cash flows to pay its bills.
It can be exciting to see how your company compares to the industry, but the greater benefit is to act on the information. If a weakness can be detected while it is still small, then you may be able to avoid a major problem. Look for ways to improve on that weak area. If the current ratio (current assets compared to current liabilities) is too low, can you keep more cash in the business instead of distributing it? Or can some expensive asset purchases be financed with a 3 year note instead of the line of credit? Perhaps a big change isn’t necessary, but small tweaks could help. Maybe some less necessary expenses could be minimized. On the other side, maybe revenue could be increased. The company may have certain types of work that are less profitable. If so, consider doing less of that work or charging more for it.
Comparing your company to a healthy industry benchmark may not automatically improve a company’s performance, but it allows the entrepreneur to see strengths and weaknesses and then adjust the company’s path accordingly. Applying industry and benchmark information to your company improves performance. Talk with your CPA for a business health checkup.