There are a number of reliable sources of industry benchmarking data available, and tapping into those allows you to compare financial performance across a range of important metrics – profit margin, debtor days, margin of safety, and more. Let’s hop in.
Financial Ratios and Benchmarking Examples
“Benchmarking” is in itself a rather broad term – there is a depth of variety in the types of benchmarking data that business can use to compare their own financial performance with that of their competitors. In this article, we’ll take a look at some of the most common and broadly applicable ratios, which can be used to benchmark your business’ performance.
Gross Profit (GP) Margin
Working out your GP margin shows you the profitability of your product(s) and/or service(s). The higher your GP margin, the more you’re earning for every dollar of revenue. This ratio is particularly valuable for tradespeople (plumbers, carpenters, electricians etc.) to determine the profitability of a job when factoring in materials and labour costs, informing how they price their services. The same applies to manufacturing businesses, allowing them to price their products in such a way that it covers the costs of production, and ensures sufficient profit left over. This ratio can also indicate your ‘breakeven point’ by dividing your fixed overheads by the GP Margin percentage to calculate the amount of revenue required to breakeven.
Net Profit (NP) Margin:
Your NP Margin ratio measures your business’ profitability as a percentage of total revenue, typically excluding the owner’s remuneration. This is useful if you are planning on investing in a business that is operating under management, and looking to determine your return on investment (ROI). Benchmarking your GP and NP against the competition is straightforward – if their GP and NP margins are higher than yours, they’re making more money.
The debtor days ratio measures how long it takes on average for income to be collected from customers. This is extremely important when you extend credit (i.e invoices) to customers, because if the debtor days exceeds your payment terms, you’ll almost certainly see cash flow issues in the future if not actioned in time. Should your average debtor days be higher than your industry’s average, this is an indication that your average competitor is enjoying more predictable cash flow and their customers generally pay on time. If your debtor days are lower than the average, you’re in good shape – your customers typically pay within agreed terms, and your cash flow should reflect that fact.
Wages as a percentage of sales:
Wages as a percentage of sales allows you to assess how effectively your businesses leverages its team, by assessing their overall costs in comparison to sales. Should your percentage be significantly higher than the industry benchmark, this might indicate one or more of the following: your employee wages are too high; you have too many employees; or they’re not 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 – indicating capacity to take on additional employees – or you as an owner are doing a lot of work and not being appropriately remunerated.
Margin of safety:
The margin of safety ratio demonstrates how much of a decline in sales your business is able to withstand until losses start to occur. Businesses that experience seasonal demand often find great value in determining their margin of safety. However, all businesses can use it to prepare for a downturn such as a global pandemic. It allows you to determine the threshold your business can reach before significant adjustments are required for survival. If other businesses in your industry have a higher margin of safety, they’ll be better equipped to weather the storms of tough trading conditions.
Combining Forecasting & Benchmarking for your Business Strategy
The ratios above, and their associated industry benchmarks, are by no means an exhaustive list – many others exist and can give you critical information to grow your business and safeguard its financial performance. This is especially true when you combine benchmarking with forecasts – using benchmarking data allows you to project the future performance of your business with the relevant benchmarks forming key performance indicators (KPI’s), informing decisions around budgets. Following that, forecasts can be used as a yardstick to compare your real results to your budget. You will then have the tools to determine what you have done well, and where improvements are required. Forecasts also act as an effective decision-making tool by considering ‘what-if’ scenarios (incorporating your “margin of safety” ratio).
Clients of People + Partners benefit from an ongoing relationship with their client manager, with access to a broad range of services that facilitate business growth. Our finger is on the pulse, we have access to industry-specific information and benchmarks, and can leverage our extensive in-house expertise to prepare forecasts & budgets that guide you towards your business and financial goals.
If you’re ready to see how your business ‘stacks up’, you can reach us on +61 2 9093 1311 or via our website.