Are you ready to grow your business or take on more jobs and customers? Are you financially where you believe you should be? Are your company’s finances balanced at all? Don’t get overwhelmed –financial performance benchmarking can help you answer all of these questions. Essentially, benchmarking is the process of comparing a business’s current financial performance with its past performance, industry standards, and the processes, operations, and financial state of other top performers in the industry.
Financial performance benchmarking isn’t really a difficult task, as long as you’ve kept good records over the years and can gather data about the construction industry and its leaders. Once you’ve done so, you’ll be able to assess positive and negative trends, identify areas where your company excels, and improve less productive areas to achieve optimum results. With this information, you’ll be able to determine if you have a strong enough cash flow to take on the debt that often comes with expanding or whether you need to take the time to work on internal processes first.
This is why benchmarking is so essential. Without it, you don’t know where your construction company stands. You can’t tell if you’re doing better than you have before or if you’re anywhere near the leaders in the industry. You can’t tell if your profit margins are the same as those of others within the construction industry or if you’re making much less than you should be.
But if you’ve never done benchmarking before, where do you start? Here are some helpful tips.
The first thing you need to know before you can start making use of financial performance benchmarking is what you have to calculate and compare. The construction industry uses a large number of important ratios which serve as benchmarking goals. You’ll need to calculate these ratios, both for yourself as well as for the construction industry in general and its top performers. This often requires you to spend some time researching other businesses.
Let’s take a look at these ratios, why they’re important, and how you calculate them.
Revenue to Working Capital = Total revenue / (current assets – current liabilities)
Your revenue to working capital shows you how well you’re doing with respect to using your working capital. If you calculate this ratio and see that it’s fairly low when compared to previous years or to other construction companies, this means that you’re not using your assets as effectively as possible.
Return on Assets = Percentage of profit earned, to overall total assets
Your ROA lets you know how effectively you’re using the assets you have to generate income. You can look at your ROA before you take out any taxes or after you take out taxes. Just remember to always calculate ROA in the same way so that you can get a consistently accurate comparison.
Debt to Equity Ratio = How much money the owner(s) have invested versus how much money is brought in from outside creditors
Your debt to equity ratio shows how much of your funding has come from taking out loans and other types of debt. If you’re planning to grow your company, you want to carefully watch this ratio and make certain that you haven’t committed your company to more debt than you can effectively manage.
Revenue to Equity = revenue / owner’s equity
The better this ratio is, the better you’re utilizing the equity the owners of your company have invested. A good goal is to have a 15:1 revenue to equity, although ideally you want 10:1.
Revenue to Net Fixed Assets
Looking at your revenue to net fixed assets can help you determine if you’re under-utilizing some of your fixed assets. If this ratio is fairly low, but you have a high depreciation to revenue ratio, you need to evaluate how you’re using your equipment and consider selling equipment which you are not using.
There are a number of other ratios you may want to also consider. These include:
- Liquidity ratios, or the amount of short-term debt you can pay with your short-term assets
- Current ratio, or the current assets / your current liabilities
- Working capital, or your current assets / current liabilities
- Leverage ratio, or your ability to meet your long-term debts
- Revenue to equity, or the revenue/equity.
- Credit management, which is how many days it takes for your accounts receivable to be paid.
Making Your Performance Benchmarking Effective
Now that you know what you need to measure for financial performance benchmarking, it’s important to know how to perform this benchmarking effectively. First, you need to make use of a formal benchmarking process. This means creating a benchmarking document that outlines how you will measure your construction company’s performance. It means identifying the companies you’ll use as industry experts, determining where you will get your data from, and deciding how you’ll calculate some of the ratios (pre-tax or post-tax).
You also need to make benchmarking something that’s routinely done in your company. It should be an on-going part of the decision-making process and something that becomes integrated into your company culture. Yes, it will take some time to get the process going and to make it part of the routine, but it’s important that this gets done.
Finally, you need to make certain that any process you decide to implement or change due to benchmarking is tracked and later evaluated in order to determine if you truly did save money or become more effective. Just because something appears to be a good idea from benchmarking doesn’t mean that it’s going to be immediately effective.
Benchmarking Takes Time and Work
Benchmarking is a very powerful tool you can use to grow your business, but it’s not something you can implement instantly. It takes time to get to the point that you can compare yourself to other construction firms. However, it’s well worth the effort, because benchmarking gives you hard data upon which to base decisions.