In the corporate environment, benchmarking helps organizations to rate their performances against those of their competitors. Consequently, benchmarking is a viable tool for propelling an organization to great heights. For instance, benchmarking can aid an organization in establishing its internal goals, pointing out market opportunities, exploiting competitors’ weaknesses, and creating an air of motivation among its staff members. Most financial benchmarks are dependent on the particulars of a company’s financial statement. Consequently, benchmarking requires ardent gathering of financial information for it to be helpful to an organization. This paper presents a discussion of benchmarking in respect to corporate finance.
Financial information can be evaluated so as to achieve various goals and objectives in respect to benchmarking. Financial statements often reflect market information and this makes them viable benchmarking tools. For instance, in cases where financial statements cannot be relied on, market value information can always be used to substitute the unreliable data. In corporate financial terms, benchmarking is restricted to the need for “comparing ratios for one business with average or representative ratios” (Ross, Westerfield, & Jordan, 2008, p. 71). Using this methodology, the ratios that fall below the identified benchmarks are due for evaluation and rectification. Benchmarking also applies to both internal and external environments of business.
Some of the most common financial benchmarks involve various aspects of performance statements. For instance, profit margins of all types including gross, net, and operating profits are the most commonly used financial benchmarks. For example, a banking firm can use the profit margins of the most dominant banks as benchmarks. The reasoning behind this type of a margin is that both organizations operate under similar financial environments. Another viable financial benchmark is revenue per employee. Revenue per employee dictates the output of each employee in fiscal terms. Salary and compensation data is another commonly used financial benchmark (Lam, 2012). A majority of organizations use their peers’ salary benchmarks while they are compensating their own employees. The ratio of fixed assets versus revenue is also a viable financial benchmark that can be applied in gauging a company’s performance.
At any given time, any organization has a wide range of benchmarks to choose from. Consequently, each organization needs to have a valid mode of choosing a benchmark (Ross, Westerfield, & Jordan, 2008). One possible method of choosing a benchmark is through the time trend analysis where a company uses history as a guide. Time trend analysis eliminates the risk of benchmarking using data from a company that is on a downward trend. For example, a company might post an enviable profit-margin benchmark. However, upon investigating the company’s history, it might become clear that its profit margin has been on a decline over the years. The time trend analysis is used to cover various angles of the financial benchmark analysis. Peer market analysis is another viable method of choosing a financial statement benchmark. Peer market analysis is used by companies to evaluate organizations that “compete in the same markets, have similar assets, and operate in similar ways” (Ross, Westerfield, & Jordan, 2008, p. 72). Peer analysis is not dependent on the need to emulate the operations of other companies, but by the need to gauge performance subjectively. For instance, organizations that work in the same fields such as manufacturing, finance, and agriculture among others are bound to share some operational similarities. Consequently, industry peers are dependent on peer analysis when it comes to benchmarking.
Another issue that is pertinent to industry financial data benchmarks is the avenues where this data can be sourced from. Access to financial statements is limited to shareholders of a company and other relevant parties. For instance, only public limited companies are required to publish their financial statements publicly. However, there are other avenues where financial data can be sourced. For example, “the Internal Revenue Service Corporate Sourcebook offers summary balance sheet and income statement numbers for all industries by size of company” (Kouzmin, 2009, p.125). Any interested parties can access this information on demand. Another common source of financial data is the annual financial reports of various companies. End of year financial results are items of interest to all companies that work in related fields. However, the job of evaluating the benchmarks that dominate financial statements belongs to the benchmarking organizations. Other avenues for sourcing benchmarking data include statistic bureaus, business census organizations, and labor organizations.
Benchmarking is not a foolproof business strategy but it also has its pitfalls. For instance, financial benchmarking is the source of various limitations that apply to the organizations that use it. First, the assumption that businesses operate under similar financial environments is flawed especially where conglomerates are involved. For instance, a business that operates as a conglomerate is subject to the financial environment of its parent company. Another shortcoming of using competitors’ financial data as a benchmarking tool is that this information may not apply where geographical distance is a factor. For example, it might be wrong to assume that a company that is based in China experiences the same financial environment as another company in the United States of America.
Kouzmin, A. (2009). Benchmarking and performance measurement in public sectors: Towards learning for agency effectiveness. International Journal of Public Sector Management, 12(2), 121-144.
Lam, M. (2012). Neural network techniques for financial performance prediction: integrating fundamental and technical analysis. Decision Support Systems, 37(4), 567-581.
Ross, S. A., Westerfield, R., & Jordan, B. D. (2008). Fundamentals of corporate finance. New York: Tata McGraw-Hill Education.