Benchmarking Your Business

Presented by Edward Lette, CPA

Business Bank of Texas, N.A.

Types of Benchmarking

• External Benchmarking – Comparing key financial and performance indicators to other companies within your industry

• Internal Benchmarking – Comparing key financial and performance indicators within your company, including comparisons to history, budgets and within divisions or even projects

Financial Ratio Categories

• Liquidity Ratios

• Profitability Ratios

• Leverage Ratios

• Efficiency Ratios

Liquidity Ratios

Liquidity Ratios – used to measure the quality and adequacy of current assets to meet current obligations as they come due.

Liquidity Ratios, continued

• Current Ratio – Indicates the extent to which current assets are available to satisfy current liabilities. Usually stated in terms of absolute values (i.e., 2.5 to 1.0 or simply 2.5).

Computed as:

Current Assets / Current Liabilities

Liquidity Ratios, continued

• Quick Ratio – Indicates the extent to which the more liquid assets are available to satisfy current liabilities. Usually stated in terms of absolute values. A quick ratio of 1.0 generally is considered a liquid position.

Computed as:(Cash and cash equivalents+short term investments+net trade

receivables)/Current Liabilities

Liquidity Ratios, continued

• Days of Cash – Indicates the number of days revenue in cash. Generally 7 days is considered adequate.

Computed as:

(Cash and cash equivalents) * 360 / Expenses-Depreciation

Liquidity Ratios, continued

• Working Capital Turnover – Indicates the amount of revenue being supported by each $1 of net working capital. A ratio exceeding 30 may indicate a need for increased working capital to support future revenue growth

Computed as:

Revenue / Working Capital

Profitability Ratios

Used to assist in evaluating management performance.

Profitability Ratios, continued

• Return on Assets - Indicates the profit generated by the total assets employed. A higher ratio reflects a more effective employment of company assets. This ratio is generally presented in terms of percentages.

Computed as:

Net Earnings / Total Assets

Profitability Ratios, continued

• Return on Equity – Indicates the profit generated by the net assets employed. This ratio reflects the stockholders’ return on investment as a percentage.

Computed as:

Net Earnings / Total Net Worth

Profitability Ratios, continued

• Times Interest Earned – Reflection of the company’s ability to meet interest expense from operations. Overall indicator of leverage balance

Computed as:

Net EBIT / Interest Expense

Leverage Ratios

Leverage ratios are key measurements in determining the company’s vulnerability to business downturns as well as the capacity for credit and internal capital needs. These ratios consider various relationships between stockholders and creditors, owners investment in fixed assets and others.

Leverage Ratios, continued

• Debt to Equity - Indicates the relationship between creditors and owners. This relationship varies on type of industry / specialty.

Computed as:

Total Liabilities / Total Net Worth

Leverage Ratios, continued

• Revenue to Equity – Indicates the level of revenue being supported by each $1 of equity.

Computed as:

Revenue / Total Net Worth

Leverage Ratios, continued

• Asset Turnover – Measures the level of revenue being supported by each $1 of assets. This is a good measurement for the effectiveness of asset expansion.

Computed as:

Revenue / Total Assets

Leverage Ratios, continued

• Fixed Asset Ratio – Measures the level of stockholders equity invested in net fixed assets. Need to consider the effect of off-balance sheet financing.

Computed as:

Net Fixed Assets / Total Net Worth

Leverage Ratios, continued

• Underbillings to Equity – Indicates the level of unbilled contract volume being financed by the stockholders. Generally a ratio of 30% or less is target.

Computed as:

(Unbilled Work + Costs in Excess) / Total Net Worth

Leverage Ratios, continued

• Backlog to Equity – Indicates the relationship of signed or committed work to total stockholders’ equity. High ratios may indicated the need for additional permanent capital.

Computed as:

Backlog / Total Net Worth

Efficiency Ratios

Measurements of the effectiveness of utilizing current assets and managing current liabilities.

Efficiency Ratios, continued

• Backlog to Working Capital – Indicates the relationship between committed work and working capital. High ratios may indicate the need for additional permanent working capital.

Computed as:

Backlog / Working Capital

Efficiency Ratios, continued

• Months in Backlog – Measures the number of months needed to complete all committed work.

Computed as:

Backlog / (1/12 of revenue)

Efficiency Ratios, continued

• Days in a/r

• Days in a/p

• Days in inventory

All indicate the number of days to liquidate.

Computed as:

((Net a/r - Retainage) * 360) / Revenue

(Accounts Payable – Retainate) * 360 / Total cost

Inventory * 360 / Cost of Sales

Efficiency Ratios, continued

• Operating Cycle – Indicates the length of time for the company to complete a normal operating cycle. A low ratio may indicate a need for more working capital.

Computed as:

Days in Cash + Days in A/R + Days in Inventory – Days in A/P

Others

• Gross Profit

• Interest as a Percentage of Gross Profit

• Coverage Ratios

Now What?

• Understand the limitations of industry comparisons

• Understand the importance of historical comparisons

• Build a list of key performance indicators for your company and build goals around improvement

• Work with your users to determine what is important to them

Benchmarking Your Business

Questions?