Benchmarking – Week #22 of The Financial Operating System®

Benchmarking is the practice of comparing business performance against industry peers. It provides insights into strengths, weaknesses, and realistic performance goals.

Key Concepts:

1. Purpose of Benchmarking:

   • Business owners seek benchmarking data to compare their financial metrics with peers or industry averages.
   • Benchmarking helps identify gaps in performance, set financial targets, and increase credibility when presenting goals to teams.

2. Challenges in Benchmarking:

   • Lack of Data: Accurate and standardized benchmarking data for small businesses is often unavailable.
   • Varied Accounting Practices: Differences in bookkeeping and accounting methods (e.g., GAAP vs. tax-basis adjustments, owner compensation treatment) make comparisons inconsistent.
   • Wide Performance Ranges: Some businesses are highly profitable and growing, while others struggle, making averages less meaningful without proper context.

3. Effective Benchmarking Practices:

   • The best benchmarking approach involves tailoring metrics and targets to align with individual business objectives.
   • Using averages as a reference point, businesses can contextualize their unique situations.

4. Default Benchmarks for Healthy Businesses:

   • Labor-Loaded Gross Profit Margin: 40% of revenue.
   • Marketing & Sales and General & Administrative (SG&A) Expense: 30% of revenue.
   • Operating Profit Margin: 10% of revenue.
   • Cash Multiple: 1.5X monthly expenses.
   • Pretax Return on Invested Capital (ROIC): At least 50%.

5. Limitations of Industry Benchmarks:

   • Most businesses do not share their financial information with benchmarking services, leading to incomplete datasets.
   • Benchmarking alone cannot provide the full context of financial performance; deeper analysis of a business’s financial objectives and metrics is needed.

6. Benefits of Tailored Targets:

   • Allows businesses to focus on specific financial goals and their own opportunities rather than chasing or settling for industry averages.
   • Helps set realistic targets that account for a company’s size, resources, and industry dynamics.

Practical Insights:

Benchmarking is an essential tool, but its success depends on using accurate data, tailoring benchmarks to individual objectives, and ensuring the benchmarks align with long-term financial strategies. Businesses must balance aspirations with the reality of their operational capacities while continuously refining their financial practices.

Next Step:

Business owners can self-implement The Financial Operating System. Chapters are available to download at smartbooks.com/resources or you can buy the whole book from Amazon (the marketing firm version or the general business version).

If you would like assistance with implementation or would like to accelerate results for your business, please contact author Cal Wilder at cwilder@smartbooks.com or book a free consultation with our team directly using this calendar link.