Gain a competitive edge by comparing metrics.
The phrase “business as usual” means something completely different than it did before the recession. “Business as usual” now includes continual improvement—learning how to do business better, faster and with fewer resources—to stay ahead of the competition. Benchmarking (measuring performance against a standard) is the key to continual improvement.
As famed management thinker Peter Drucker put it, “You can’t manage what you can’t measure.” You need metrics to measure improvement. To establish your business performance metrics, you must conduct an in-depth review of your business processes, and compare your business against the best in the industry. Benchmarking against the industry best supports the case for change.
Benchmarking also adds significant value to your business by providing a management tool to assess your company’s current performance and identify areas that need improvement. Priorities can then be set, and progress can be tracked.
Use the Right Financial Benchmarks
In the current market, your financial health will be examined more than ever by creditors, banks, sureties, customers and governmental agencies, to name a few. Banks and sureties, in particular, use certain financial benchmarks when deciding whether to extend credit or bonds. With so many eyes on your company’s financials, it becomes increasingly important to know how you stack up against the competition.
When measuring your company’s financial health and performance, use these three broad ratio categories: liquidity, profitability and leverage.
Compare Metrics
Benchmarking can be used to compare metrics over time and against industry standards. Comparing the same ratios over time is a great way to identify trends. If certain ratios steadily improve, it may suggest an improvement in your company’s operations or financial situation. Ratios that decline can highlight problem areas.
As your company’s ratios improve over time, also consider how they stack up against the competition. This will indicate if your company is as well-positioned or well-managed as other industry players.
Benchmarking is the starting point to spot areas that need improvement. For example, if the best-in-class return on equity is 15 percent, and your company is currently at 9 percent, setting the target at 15 percent is a great first step. To achieve the desired 15 percent, you and your management team must dig deep into your company’s operations. Benchmarks do not provide the answer, but they do highlight where your energy and resources should be spent.
You can also establish baselines to monitor. For instance, a common baseline might be a bank-imposed covenant, such as maintaining the maximum debt to equity or minimum working capital. If this baseline is not achieved, the benchmark will spotlight the shortcoming, and management can take steps to correct the problem.
Benchmarking often triggers the need to make necessary changes. Therefore, management buy-in to this process is necessary.
To track benchmarks, use a tool as simple as an electronic spreadsheet to easily manage and calculate the ratios from the financial statements. A computer application such as Excel (with the appropriate controls and review of data inputs and formulas) provides an efficient way to make the financial benchmark a standard management report.
Access Credible Data
The most critical component of successful financial benchmarking is using credible data. For best results, use data from similar-sized companies and, where possible, within your own geographic area.
To avoid skewing the number, use a source that represents a large universe of input. Choose the industry group [usually based on the North American Industry Classification System (NAICS) code] that best represents your business.
Your management team’s objective should be to make wise business decisions with the goal of increasing the company’s profit. Analyzing financial ratios provides a way for your management team to better understand your company. It gives them the opportunity to learn more about your company’s past, present and projected future operations. And comparing your financial ratios to industry leaders can add even greater insight.
CFMA is an organization focused on the educational needs of the construction financial professional. With more than 6,500 members in 87 chapters across the United States and Canada, CFMA provides financial experience and expertise to construction firms. CFMA’s Construction Industry Annual Financial Survey is available in four editions for different construction sectors. This month, CFMA holds their annual conference on May 14-18 in Grapevine, Texas. To learn more, visit cfma.org.
Construction Business Owner, May 2011
