What is Business Benchmarking?
Understanding Business Benchmarking is very much about understanding how industry considers and values businesses.
For a small business owner, this is often a nervous and scary subject due to the amount of misinformation and misunderstanding involved.
Benchmarking is taken from comparing all the available statistics across similar businesses (size) in your industry and occupation. Also don’t forget that this shows the benchmark of all of them, even the ones that have failed. In my opinion if you are achieving just the published benchmarks, you are setting yourself up for failure. You want to be well ahead of the crowd when it comes to your Business Benchmarking results.
Benchmarks can be across areas such as planning and managing and reporting on suitable established KPI. The financial ones are focused on turnover, the ratios of Gross Markgin, COGS, and a list of common running (fixed) expenses. The most common used as a “final figure” to look at in business to see and set the business value is EBIT – Earnings Before Interest and Tax.
EBIT – is basically the business earnings (net profit = turnover – cost of goods (variable expenses) – running (fixed) expenses; including any portion of interest and taxation payments.
By taking out the Interest component, comparisons between different businesses irrespective of their financing arrangements are possible, thus focusing on their underlying profitability.
Tax is also taken out of this measure to keep the focus on underlying operational performance which may be distorted by different ownership structures and deductions claimed.
EBIT, however, does include Depreciation, so a profit return on Capital Assets is a part of this measure. This is highly influenced by how asset are owned or leased and what depreciation pools you have. Both have the effect of reducing expenses, but by including depreciation, the effect of these decisions is relatively neutral when using this measure.
EBIT is then usually represented as a Turnover:EBIT ratio so that the fluctuation across different businesses in the same Industry/Occupation can be compared.
ROA (Return on Assets) is the ratio of EBIT to Total Assets. This gives an indication on the return on the value of the business’ assets. This excludes any financing effect which is why Interest is added back to earnings. This ratio provides an indication of the effectiveness of the utilisation of assets in the business. A low figure would indicate that the business is operating under capacity or poor efficiency in asset utilisation. Effective Business Benchmarking for ROA should be >25%.
ICR (Interest Cover Ratio) is the ratio of EBIT to Interest. This ratio indicates is how easily the business can cover the interest payments for any debt they are carrying. An ICR of < 1 could indicate difficulty in the business generating enough earnings to meet their debt repayment obligations. Investors generally consider a ratio of less than 1.5 as in the danger zone for a business. Effective Business Benchmarking for ICR should be >10.
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