Most small business owners are curious to know how they compare with other small businesses in their industry, especially in regards to their financials. This is financial benchmarking and it is easier to do than you might think.
Financial benchmarking is important to a small business. It allows you to see how your business is doing in comparison to the average in your industry. It is comparing not to the best in your industry and not to the worst, but to the average. With this information, you can see which parts of your business are doing well and which parts need attention. The comparison is good actionable information and you can continue to compare yourself over time to see trends, especially if you have taken action to improve in an area.
Your financial statements such as the profit and loss and balance sheet must be in good order to properly benchmark. Financials with inaccurate and incomplete information do not allow you to effectively benchmark. We have all heard the acronym GI-GO, garbage in-garbage out.
Once you develop a good set of financial statements, you can obtain a set of financial ratios for your industry from various sources. Ratios are a comparison between two numbers, such as the relationship between sales and gross profit expressed as gross profit/sales. Using the profit and loss statement and the balance sheet, you can calculate many other ratios that are important to your business. Every business falls into an industry using NAICS codes, which stands for North American Industry Classification System codes. Find the NAICS code that best fits your business, obtain a set of industry financial ratios and then calculate your ratios to see how you compare.
Banks use industry financial ratios to compare numbers from their client’s financials. The ASU Small Business Development Center can run an industry ratio report on your NAICS code as well. We can then input numbers from your financial statements and have the report show how you compare to industry. In addition, we could discuss a plan of action with you on how to improve in areas of concern. Your accountant can also perform this service.
Consider using benchmarking to help understand how your business is trending financially compared to other like businesses in your industry, which will help you to discover areas that can be improved leading to better profits and cash flow.
“Business Tips” was written by Dave Erickson, Director and Certified Business Advisor, of Angelo State University’s Small Business Development Center. For more information on the topic of this article or the services of the ASU · SBDC, contact him at David.Erickson@angelo.edu.