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Benchmarking – How Does my Business ‘Stack Up’?
Have you ever wondered how your business ‘stacks up’ against similar businesses in your industry? What are all the other businesses doing that may be different to yours? What if there was a way you could measure the financial performance of your business on a regular basis? All of the above questions (and many more) can be answered with the use of benchmarking. There are various credible industry benchmarks available to assist in analysing your business performance to see how it compares with the rest of the industry.
Benchmarking – In Different Shapes and Sizes
Benchmarking can take many forms; however, the most commonly used format is as a percentage or ratio which can be applied to your financial data. Examples of the commonly used benchmarks include:
Gross Profit Margin
This ratio helps determine the profitability of your product(s) and service(s). The higher the gross profit margin, the more you are earning for every $1 of revenue. This benchmarking ration is particularly useful for plumbers, electricians and other trades to determine the profitability of a job when factoring in materials and labour costs. The same applies to manufacturing businesses to ensure that their pricing methodology is correct and covers the costs of producing a product. Having this ratio can also lead to determining your ‘breakeven point’ by dividing your fixed overheads by this percentage to calculate the amount of revenue you need to breakeven.
Wages as a % of Sales:
Wages as a percentage of sales allows you to assess the utilisation of your staff by assessing their overall costs in comparison to sales. Should your percentage be significantly higher than the industry benchmark, this may mean that you are paying too much for your staff, you may have too many staff members, or they’re not being as productive as they should be in generating revenue. If the ratio is significantly lower than the industry benchmark, it may indicate that your labour resource is spread too thin and there is capacity to take on an additional staff member and/or yourselves as owners are doing a lot of work and not being appropriately remunerated for it.
Margin of Safety:
The margin of safety ratio helps demonstrate how much of a fall in sales the business is able to withstand until it starts to incur losses. It may be beneficial to run this scenario if your business is quite seasonal throughout the year or if you anticipate rough trading conditions (e.g. a global pandemic). It allows you to determine your business’ threshold it can reach before you need to make adjustments in order to survive.
Net Profit Margin:
This ratio is a measure of profitability of the business as a percentage of total revenue and typically excludes the owner’s remuneration. It’s particularly useful if you are investing in a business that is operating under management and you are looking to determine what you could potentially earn from the business, and subsequently it’s return on investment.
The debtor days ratio measures how long it takes on average for your income to be collected from debtors. This ratio is extremely important when you extend credit (i.e invoices) to customers because if the debtor days exceeds the industry terms (or your own debtor terms for that matter) it may result in cash flow problems in the future if not actioned in time.
Benchmarking – Part of your Overall Business Strategy
While the above are only some of the benchmarks available for businesses, there are many others at your disposal to help measure your financial performance. When combined with forecasts, the use of benchmarking data allows you to project the future performance of your business with the relevant benchmarks forming key performance indicators (KPI’s) and informing decisions around setting a budget. From there, you can use these forecasts as a measuring stick when comparing your actual results to the budget to determine what you have done well and what aspects of the business needs to be improved upon. The forecasts can also act as an effective decision-making tool by implementing ‘what-if’ scenarios.
Benchmarking – In Practice
For example, what if you were to take on an additional employee – how much of a financial impact does it have on the business’ bottom line, and how much revenue do they need to generate to cover the cost? Or what if you need to purchase a piece of machinery, can the business afford to pay for it in cash, or alternatively, what does the outbound cash flow look like if you were to finance it? There are many other common business scenarios which can be accurately projected using benchmarking data, the results of which promote effective decision making and foster business growth.
The Bottom Line
At McKinley Plowman, we have access to various industry-specific financial information and benchmarks as well as the expertise to prepare forecasts to assist in guiding you towards your business and financial goals. Let’s start the new financial year on the right foot – call us today to see how your business ‘stacks’ up on 08 9301 2200 (Joondalup) or 08 9361 3300 (Victoria Park); alternatively you can contact us via our website.
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