November 25, 2022

Small Business Advice

Benchmarking

Jerry Osteryoung | 4/28/2008

Leaders learn by leading, and they learn best by leading in the face of obstacles. As weather shapes mountains, problems shape leaders.
— Warren Bennis

One thing every firm needs to have in place is a system to measure their performance against an industry average or some other criteria. Benchmarking is one such way to compare your firm’s performance against others to get an idea of how you are doing. In addition to sales growth rates, you may benchmark against advertising expenses as a percent of sales, debt to total asset ratios, gross profit margins and net profit margins, as well as a number of other operating and financial figures.

When it comes to measuring how well your firm is doing, you just cannot compare past performance with the current year’s performance in isolation of what other firms are doing. One of the firms we were helping thought that their six percent growth in sales from last year was evidence of how well they were doing. However, as the industry average for the same period was 12%, it was clear that they were not doing nearly as well as they thought there were.

A restaurant that we are working with had a cost of food percentage (food costs divided by sales) of 56%. The owner thought he was doing ok, but the typical benchmark for restaurant food costs is right around 30%. The owner did not really understand how far off his food costs were as he had no basis of comparison.

After working with him and showing him these numbers, this restaurant owner was able to reduce his food costs to 35% with more reductions to go — all within a period of one year. Additionally, his net profit margin went from almost zero to ten percent, and his dollars of profit skyrocketed. For this entrepreneur, the reduction in food costs was easy once he had a goal in mind, and that is exactly what benchmarking does.

It is important to bear in mind, however, that with most numbers, you cannot take an industry average or benchmark as a perfect goal or standard. Rather, benchmarks should be used as a guide, and you must use judgment to interpret what the results are really saying. For instance, in many cases, firms’ net incomes are much larger than the benchmark. However, this is frequently caused by the owners’ desire to take out distributions of profits rather than salaries.

There are a number of neat places that provide information about benchmarks. One such source is www.bizstats.com, which offers some of this information free of charge.

The source I consulted is Financial Research & Associates (FRA) who, for the last 23 years, have issued an annual book reporting firm benchmarks. Most of their data comes from accountants who produce financial statements for companies, and the figures are broken down enough to provide a good industry comparison and benchmarks. The cost for this book is around $140.

Another source I used is the RMA Annual Statement Studies. This database is much larger than the FRA, and the data comes from financial statements provided to commercial banks by accountants. It shows 16 "classic" financial ratios, each grouped by industry: current ratio, quick ratio, sales/receivables, cost of sales/inventory, cost of sales/payables, officers compensation/sales, gross and net profit margins, and more. This is a great data source providing a wealth of information, but the cost per year will run you about $500.

The bottom line is that there are many sources of financial information that can be used to benchmark your company’s performance. Every firm should utilize benchmarks in order to ensure that they are properly measuring how well they are doing.

You can do this!

Jerry Osteryoung is the Jim Moran Professor of Entrepreneurship in the College of Business at Florida State University. He is also the Director of the Entrepreneurship Program at FSU and Executive Director of the Jim Moran Institute of Global Entrepreneurship. He can be reached by e-mail at jostery@comcast.net or by phone at 850-644-3372.

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