3 Ways CFOs Should Use Financial Benchmarking

By |2018-07-27T18:47:45-05:00July 27th, 2018|

It is no secret that today’s business landscape moves faster than ever before.

Fueled by an insatiable appetite for technology, industries are morphing in months, not years. Smart executives are terrified that their business could get “Ubered” by a tech savvy startup, untethered by history. The Ubers of the world are rewriting how industries are profiting. But, there are dozens of other factors shifting the sands of industry too. For instance, the Trump administration has introduced a landslide of changes in regulation, tax laws, and tariffs—most of which is still unfolding.

With so much uncertainty, how can CFOs and CEOs trust their strategy?

The answer lies in the data.

Navigating today’s ever changing world requires looking not only at the data from your own books, but placing that data in context with the rest of your industry.

Financial benchmarking is that context. Financial benchmarking provides a company-to-industry analysis that—when used alongside existing reporting—communicates a better assessment of a company’s true performance.

To see what this means in real terms, let’s take a look at a $22 million plastics manufacturing company. A quick review of their P&L shows sales have been increasing over the past four years along with profit. On paper, the financial health of the company appears good. Once we put the P&L in context with the rest of the industry, we start to see a different story unfold.

Financial insight

Financial reporting is meant to provide insight into the financial performance of a company. It should identify weak performing areas so that corrective action can be taken before they become critical.

That is tough to do when you just compare it against your own past performance. Seeing how sales or profit margins vary month to month or how expenses compare to the budget is not providing insight, but merely measuring progress. Rather, effective insightful reporting should tell you something you don’t already know. It should drive questions and create a call to action.

For instance, when we used CxO Analytics to benchmark our plastics company against 71 same-size companies in its industry, we see the company’s sales ranks near the top 25% of the industry, while profitability is in the bottom half of the industry. This information is a cue to work on profitability.

Financial Benchmarking, Measuring Profitability, Return on Sales, Profit per Employee, Sales per Employee

Digging in, we see immediately that our plastics company is suffering from not enough profits per employee. This could mean the company employs too many people, or the sales force is not effective. Both of these are serious implications for the company’s core asset: its people.

Another avenue could be that the price is too low. This is not uncommon. In fact, a McKinsey study revealed that 80-90% of all poorly chosen prices were too low. This scenario can translate to substantial impacts on your bottom line. Underpricing by 1% is known to reduce operating profits by 5-10%.

Financial Benchmarking, Return on Asset Investment, Gross Margin and Assets to Sales

Further exploration shows that gross margins are decent and could benefit from some price increases. However, the real problem is that the volume isn’t substantial enough.

This kind of statistical, real world financial benchmarking helps to triangulate problem areas and substantiate the opportunities for improvement. The issues are no longer opinions, they are clear facts that were not apparent by simply reading the company’s financial history in isolation.

The fact that the CxO Analytics tool can help model improvements and project their impacts is also handy to establish new goals. For instance, the above example shows instantly how changes to costs, price or volume can align returns with your industry. Of course, savvy CFOs know how to model these changes independently, but financial benchmarking provides context and unparalleled confidence for establishing meaningful targets.

Risk management

Most risk categories expose companies to financial impacts in terms of extra costs or lost revenue. As the financial keeper of the company, the CFO is the company’s primary risk manager.

Of course, some types of risks like errors & omissions can be mitigated by insurance. However, the most vital to normal operations, require careful financial oversight.

Consider cash flow, the very heartbeat of a company and something the CFO actively monitors. Typically, CFOs look to current and quick ratios to measure the company’s cash flow or liquidity position.

The general guidelines state a current ratio of less than 2 or a quick ratio of less than 1 indicates a potential cash shortage. Our plastics company reports current and quick ratios of 1.24 and 3.31 respectively—leading us to believe they can readily cover their current liabilities and expenses.

Looking deeper, benchmarking shows something totally different.

Financial Benchmarking. Asset Efficiency: Collection Period, Inventory Turnover, Assets to Sales, Sales to Working Capital, Accounts Payable to Sales

Unknowingly, the company is taking higher operational risks by stockpiling inventory and allowing loose collection periods. Individually each of these areas above affects the competitiveness of the company. Combined, they can have a lasting impact on its ability to sustain growth.

Increasing performance

Financial performance is more than just sales growth, profit margins, and net profits. Other key indicators such as inventory turns, collection period, and payment deferral, are just as critical.

With an expanding role, CFOs need additional reporting and data analysis to identify performance gaps not just against corporate goals, but also against other areas that affect meeting these goals. As a new standard, benchmarking helps areas of performance gaps not found in standard reporting. It provides a clear definition of the size of these gaps, helps determine effective strategies and action plans, and provides the ability to measure the financial impact on the company.

With our plastics company, areas of risk were previously identified. Now we can measure how big the performance gaps are between the company and its same-size industry peers.

Company Top 25% Financial Impact
Inventory age 132 days 22 days $ 3.9 million
Collection period 51 days 21 days $ 2.0 million
Payment deferral 26 days 35 days $ 678,802

 

What would be the impact if the CFO wanted to close the gap to meet the same level of performance as other companies in the industry top 25%? Armed with such an action plan, the CFO would increase company liquidity by over $6 million. As a result, the company could improve its operational efficiency and competitiveness—while freeing additional financial resources to grow the business.

Financial benchmarking & the CFO: Better together

Benchmarking data equips the modern CFO for the fast paced landscape of today’s business world. Financial benchmarking helps to interpret financials with more context and articulate the most important strategies for your company’s successful future. In the process they gain a competitive edge and are able to better utilize the company’s resources to drive growth.

If you’d like to see how your company stacks up against the competition, try CxO Analytics free for 10 days.