What is Benchmarking in Financial Performance Analyses?

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Benchmarking measures the effectiveness of business processes compared to industry standards. It is a classic management tool that companies use to determine the profitability of their products and services. While there are several forms of benchmarking, such as process or performance, financial benchmarking is probably the relevant, because it measures the effectiveness of money spent on operations.

The Facts

Benchmarking takes broad segments of a company's operations and breaks them down in to small, complete processes that can be measured for overall effectiveness. While benchmarking takes time and detail to implement, it is one part of company’s strategic management process to ensure industry competitiveness.

Strategic Management

Strategic management is the implementation and evaluation of certain goals or objectives a business wants to achieve. In order to measure effectiveness, a business will use benchmarking to review smaller processes or a large division. By starting with the small processes, businesses will discover deficiencies quickly and determine how to correct them; in turn, this will make the entire division more competitive.

Financial Benchmarks

Financial benchmarking examines monetary processes within business division to determine their industry competitiveness. Some examples of financial benchmarks include: Does the company spend above industry average for rent and utilities? How does the cost of materials compare to the industry? Are employee salaries and benefits competitive with the rest of the industry? In addition, financial ratios are helpful when reviewing divisions for effectiveness. For example, this could mean figuring the ratio of sales of notebooks to desktop PCs against the benchmarks of industry peers. Ratios should be tracked regularly to determine where fluctuations occur and what drives these differences.

Benchmark Advantages

Benchmarking provides quantitative results for business processes. Measuring the financial strengths and weaknesses of a divisional process gives management a clear picture of whether goals have been achieved. Another advantage of benchmarking is that it begins with smaller processes; once problems are identified, they may be easier to change than an entire division process.

Benchmark Disadvantages

Benchmarking is a very detailed process; breaking down divisions into a small, finite process is time-consuming and labor-intensive, and can be rendered completely ineffective if done improperly. Additionally, specific benchmark goals do not exist. A company must use benchmarks to determine if it is competitive to rivals and within industry standards. Benchmarking is also a continuous process that must be reviewed often to ensure that the information being gathered is still useful to the company. Refining benchmarks is a managerial process that must occur to ensure bad measurements are not being taken of division processes.

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