We talk to dozens of new prospective family business clients each year. When we get to the part of the conversation where we discuss their company’s financial performance, a rather large percentage of people say, “Our company is very profitable.” My response is usually, “Compared to what?” Smart-aleck response aside, the point I’m making is they usually don’t know if they are very profitable or not. Suppose you had a 30% gross margin and a 10% net margin as of the end of 2015. Those numbers might cause you to be quite pleased, especially if they represent improvements over the previous year. On the other hand, if you were to find out that everyone else in your industry had a 35% gross margin and a 14% net, you might not be quite so pleased with yourself.
The typical family-owned business finds it very hard to identify standards with which to measure itself. Sure, there are the basic financial ratios of current, acid test, return on assets, return on equity, etc. For most, as long as their banker is happy with the numbers, they’re pretty happy too! What they really should seek to know, however, is how they stack up on those various measures against their industry peers. What I’m talking about is benchmarking.
For example, The Family Business Institute is in a peer group with other peer group providers. Since we don’t compete with one another, we’re comfortable sharing benchmarking numbers and best practices. I’m looking at our benchmarking numbers right this minute. I am dismayed to see that FBI generated 69% less revenue per full-time equivalent employee than the best performer in our group. In fact, I’m hoping that there is a difference in the way we calculated the numbers that would help account for such a wide disparity! If it is legitimate and not a function of a calculation mistake, I need to spend time with my peer trying to determine why she’s able to generate so much revenue per employee relative to us. On a different measure, another one of our peers is outpacing FBI by a 3 to 1 margin! You better believe I have some questions about that! That’s why benchmarking financials and performance criteria is valuable; it doesn’t necessarily give you answers, but it sure provides ammunition for asking the right kinds of questions!
Benchmarking is the process of comparing the cost, time, quality, or some other measure of what one organization does against other, similar organizations. Sometimes it is called “best practices analysis.” Its purpose is to find gaps between your company’s performance and the performance of a fairly homogeneous group of others. For example, it doesn’t make much sense to compare the financials of a commercial construction firm with those of an agricultural operation; different industries require different benchmarking standards and practices. A ratio that’s quite important to one industry may have little meaning in another. Ideally, benchmarking ought to be done as part of an ongoing, continuous improvement plan and revisited with some frequency.
A few years ago, a family business came to us in serious condition following the unexpected death of the founder. Benchmarking pointed out some very important numbers. The first thing we noticed was that their debt to equity ratio was seriously out of kilter; the company basically had no book value. One reason for the company’s poor financial performance revealed itself in the collection line. Industry upper quartile performers had a collection period of only six days while this company had a collection period of well over 30. To compound the issue, they were in the habit of paying bills upon receipt which was far faster than the industry norm. Paying bills quickly while collecting debts slowly is a recipe for financial disaster in any company! Believe it or not, the recently deceased patriarch of this company was an accountant by training, but it took benchmarking and an objective eye to help point out and correct these issues.
Benchmarking isn’t a panacea for every business problem, but it is important to know where you stand relative to your industry and competition. When it comes to numbers, there are two schools of thought. One is, “The numbers don’t lie.” The other is to view the numbers as Mark Twain did: “There are lies, damn lies, and statistics.” With respect to Mr. Clemens, failing to undertake rigorous examination of your business numbers and processes most decidedly means you’re swimming upstream when it comes to the financial management of your company. Benchmarking might be the solution for you.
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