Financial benchmarking: How it works & why it matters

Financial benchmarking is the process of comparing a company’s financial results against those of competitors or industry averages.

It allows a company to see where it’s exceeding or lagging behind similar businesses. This broader context helps uncover financial or operational issues that often remain hidden when results are viewed on their own, enabling the company to launch corrective actions.

In this guide, we’ll dig deeper into why benchmarking is such a useful tool for CFOs, finance professionals and analysts. We’ll outline the key benchmarking methods, the outcomes they can achieve, the challenges involved and the software that can enable benchmarking.

Key takeaways

• Benchmarking provides critical context to fully appreciate financial results relative to those of similar or competing companies
• It provides the wider context needed to determine if results are due to internal processes/decision or external market dynamics
• Key finance benchmarking metrics include labour costs, costs of goods sold, gross profit margin, return on assets and a range of financial ratios
• Benchmarking helps a company identify strengths and weaknesses, and take action to improve efficiency and minimise risk
• Challenges include benchmarking data quality, comparability, incompleteness and obsolescence.

Let’s first break down what benchmarking involves and the value it provides for a company.

What are finance benchmarking metrics?

They are the KPIs and standards against which a business can compare its financial performance, including:  

• Internal benchmarks: These compare performance against past financial data. For instance, comparing Q3 net profit margin against the most recent quarter.
• Competitive/industry benchmarks: Comparisons against the public filings of companies with similar products/market share or industry averages.
• Functional benchmarks: A business compares specific processes against those of ‘best-in-class’ companies (that are not necessarily in the same industry). For instance, a manufacturing business compares its accounts receivable process against that of a tech company known for a highly efficient process.      

Why financial benchmarking matters

Benchmarking provides critical context about a company's financial performance. For instance, a company may increase revenue by five percent, but if the rest of the sector grew by 10%, the company has in fact lost market share.

Comparing against external benchmark financial metrics provides a reality check. It allows a company to not only track performance but also interpret it correctly, taking into account wider market and economic conditions.

Let’s dig deeper into the value benchmarking provides to businesses.

Contextual performance evaluation

Benchmarks provide a point of reference for raw financial results, allowing a company to see if they are below, above or in line with industry averages, the results of its competitors or past internal results.

It allows the company to gauge whether its results reflect internal processes or management decisions, or if they’re the result of external market dynamics. For instance, a company may look at a 10% reduction in sales as a failure. However, if its competitors’ sales are down 20% on average, the company’s performance indicates high resilience.

Realistic goal setting

Without benchmarks to guide you, financial goals tend to be either too easy or unrealistic. Industry averages, historical performance and competitor performance provide a solid base for creating challenging yet achievable goals.    

Identifying inefficiencies

Comparing key benchmark financial metrics like costs, margins, capital expenditure and debt levels against industry averages and competitor metrics helps you spot areas for improvement.

For example, if a company’s marketing spend is higher than the industry average but its return on investment is low, this could indicate issues within marketing, including a poor strategy or badly executed campaigns.

Risk management

Comparing against benchmarks provides early risk detection, helping you spot vulnerabilities before they escalate. For example, if a company’s debt-to-equity ratio greatly surpasses that of industry peers, it may indicate a high risk of insolvency in the event of an economic downturn.  

Investor and stakeholder confidence

Lenders, investors and stakeholders gain confidence in a company that understands its position in the market relative to similar companies. It shows that the company is committed to transparency and is actively looking to improve and outperform competitors.

Smarter decision-making

Knowing what industry peers are doing helps a company adapt and make more informed, strategically sound decisions. When you know exactly where you’re falling behind the competition, you can make more targeted and better decisions to cut costs or increase investment. 

Here are the key finance benchmarking metrics you can use to compare performance against similar companies.

Analysing cost structure

This involves comparing a company’s expenses against external results. This can include finance benchmarking metrics like labour costs, cost of goods sold (COGS), operating expenses or research and development costs.

Analysing cost structure involves converting each expense into a percentage of total revenue, thereby making it possible to compare costs against industry or competitor averages.

Assessing financial ratios

Financial ratios help standardise benchmarking financial metrics, allowing for meaningful comparisons across time periods and businesses. They’re generally grouped into three categories:

• Liquidity ratios: These measure the company’s ability to honour short-term debt obligations. Includes the current ratio, quick ratio and cash ratio.
• Profitability ratios: Tells you how effectively the company is generating profit from sales, assets or equity. Includes gross margin, net profit margin and return on equity.
• Solvency ratios: These gauge the company’s long-term financial stability and debt risk. Includes the debt-to-equity ratio, interest coverage ratio and debt service coverage ratio.

Examining key KPIs

KPIs can include the finance benchmarking metrics discussed above as well as the likes of gross profit margin, return on assets, revenue per employee and inventory turnover. They allow a company to home in on the specific drivers of financial results.

When benchmarked against competitors, industry averages or internal targets, KPIs highlight where performance differs and where investigation into the root cause is required. They highlight trends and performance gaps, indicating where there may be issues that aren’t obvious from financial statements alone. 

By comparing KPIs externally, a company can find out whether performance is driven by internal operations or wider market/economic conditions. For example, if a company’s revenue per head is markedly lower than that of a competitor, it may suggest that it needs to invest in better technology or streamline workflows.

By placing results within the context of peer performance, consistent benchmarking helps a company to:

Identify strengths and weaknesses

Benchmarking highlights where your company is outperforming its competitors or lagging behind. It alerts you to possible financial or operational issues so you can further investigate their cause.

On the flip side, it can also tell you what’s working well compared to others, and thereby let you know where to double down on investment.

Optimise efficiency and profitability

By understanding where financial performance is lagging behind peers, the finance team can then investigate the root cause and propose corrective initiatives.

For example, financial benchmarking may reveal that your company is operating with a much lower inventory turnover rate than top-performing companies in your sector. Finance could then highlight this gap to the wider business.

This could prompt corrective action to increase the turnover rate, which can unlock significant cash flow previously tied up in stagnant stock.

Allocate resources strategically

Benchmarking allows finance and the rest of the business to home in on the most pressing issues facing the company.

For example, if it’s shown that your customer acquisition costs are far less than the industry average, but your employee turnover rate is higher, the business can shift focus onto fixing the latter issue. 

Benchmarking helps ensure the company’s limited resources are dedicated to improving those areas that need it most and will yield the highest return on investment.

Mitigate risks and adapt to market changes

Comparing key financial KPIs for liquidity, debt, margin or cash flow against benchmarks allows finance to sense market trends and implement initiatives early to mitigate potential risks.

For example, if via benchmarking finance discovers that similar businesses are suddenly increasing their liquidity and reducing debt, this could signify that the industry is anticipating a market downturn. The finance team could then take action to help weather a potential downturn.

Enhance decision-making

Benchmarking provides a company’s leadership with the wider, objective context it needs to make high-stakes decisions. It allows them to see the most pressing financial or operational issues to be addressed.

Knowing how the business compares to others gives senior executives the confidence that their corrective initiatives are backed by sound reasoning and data.

Here we’ll run you through the step-by-step process for effectively benchmarking your company’s financial results against peers.

Step 1: Set objectives and choose KPIs

Not knowing what you want to achieve via benchmarking will likely lead to collecting too much data and tracking irrelevant KPIs. Focus on a particular business aim, whether it’s boosting profitability, operational efficiency or solvency, or reducing costs. 

Once you set down your objectives along these lines, you can select the most relevant KPIs. For instance, if you want to improve profitability, you may focus on profitability ratios like gross margin and net profit margin. If solvency, you can focus on the debt-to-equity ratio or interest coverage ratio.

To ensure you’re not overwhelmed by data, choose three to five KPIs that are directly tied to the objectives.

Step 2: Source financial benchmarking data

Next, you’ll need to collect the data needed to benchmark your company’s financials against. Some of the most commonly used and reliable data sources include:

• Australian Bureau of Statistics (ABS): Provides quarterly business indicators across major industries
• Chartered Accountants ANZ: Offers annual benchmarking reports that provide finance benchmarking metrics for publicly listed Australian and New Zealand companies, as well as global companies
• Australian Taxation Office (ATO): Provides small business benchmarks for over 100 industries. These cover labour costs, cost of sales and total expenses.
• IBISWorld: Offers reports on Australian sectors that include financial ratios and five-year forecasts.

Step 3: Compare performance and analyse results

There will inevitably be some variation between your company’s KPIs and those of other businesses. Small performance gaps are normal, but large gaps will need to be investigated. It’s a good idea to compare performance over multiple periods to see if gaps are increasing.

For instance, it may be that your company’s wages and salaries as a percentage of turnover increased from 25% to 30% over the last three quarters. However, the industry average for the same period is 22%. This is a sizable and growing performance gap that warrants investigation.

Investigating a variance could mean going beyond financial figures and digging into operational numbers. You’ll need to speak to department heads to source the right data. For instance, the aforementioned variance may require you to look at staff productivity numbers to see if they’ve decreased during the period.

Step 4: Develop an action plan

Once you investigate a sizable variance to understand the root cause, create a plan with specific initiatives to help address it. Each initiative should have a clear owner, timeframe and expected financial outcome.

Using the previous example of high labour costs, your plan might include working with departmental heads to create and monitor staff productivity targets. Another initiative might involve implementing software that can automate manual tasks. 

Use the SMART goal-setting framework for each initiative; that is, ensuring goals are specific, measurable, achievable, relevant and time-bound. For instance, instead of a goal to ‘reduce costs,’ set a target to reduce labour expenses by 15% within six months.

Step 5: Continuous improvement

Regular benchmarking is critical as results can quickly become obsolete as economic and market dynamics change throughout the year. It’s a good idea to benchmark on a quarterly basis; not only to keep up with changing dynamics, but also to see if any variances are increasing or decreasing over time.

The good news is that there’s a range of software available that can simplify the benchmarking process. Here are the main types:

Cloud-based finance software

Cloud-based financial reporting software can give you real-time visibility of financial and operational data from across your company. This is thanks to their integration capabilities, which allow for data to be pulled from cloud accounting software, ERPs and CRMs. In addition to this, they can: 

• Make it easy to source and consolidate all the internal data you’ll need for benchmarking
• Allow you to create highly visual dashboards that compare KPIs to benchmarks
• Facilitate initiatives to rectify issues uncovered via benchmarking. For instance, financial management software with stock control features can enable you to optimise inventory ratios.  

Business intelligence (BI) tools

Like financial management software, BI tools such as Tableau and Power BI allow you to create visual dashboards that highlight KPI performance against benchmarks, drawing from both financial and operational data. 

They provide more advanced analysis capabilities and customisation, but come with a higher learning curve and cost.

Financial modelling tools

The power of modelling tools like Excel or Anaplan is their scenario analysis capabilities that allow you to test corrective initiatives. 

For example, if your company is lagging behind the industry benchmark for net profit, you could test a scenario where you reduce labour costs by two percent while increasing marketing spend by one percent. The tool can illustrate how those changes would change your position relative to the benchmark over the next 12 months. 

While software can make benchmarking easier, the process presents a few inherent challenges:

Access to accurate data

One of the biggest benchmarking challenges is finding high-quality and up-to-date benchmarking data from private companies, which unlike ASX-listed companies, generally don’t publicly reveal detailed financial reports.

Industry averages from the ATO or ABS can also not be ideal as they’re based on historical tax filings that could be 12 to 18 months old. Publicly available benchmarks may also be aggregated or based on broad industry classifications, which may not reflect your company’s business model or position in the market.

Data comparability

Financial benchmarking only works well when you’re comparing like for like, but many companies operate in wildly different contexts. Differences in geography, business size and model, customer mix and growth stage can skew comparisons.

For example, a retailer operating in Sydney will have a very different cost structure for rent and wages compared to a similar business in, for example, regional Queensland.

Even businesses within the same industry can vary significantly. For example, a fine-dining restaurant that needs more staff to maintain high-quality service will have a much higher labour-to-revenue ratio than a fast-food franchise that prioritises speed and automation.

Differences in accounting practices

Different companies will vary in the way they categorise expenses, recognise revenue, depreciate assets or evaluate inventory, all of which can skew KPIs. 

For example, one company may attribute delivery and freight costs to COGS, while another might record them as general operating expenses.

Small differences in the chart of accounts can make one company appear to have a much higher gross profit margin than another, even if their operational efficiency is identical.

Non-financial factors

Financial figures don’t always tell the full story behind performance gaps. Brand reputation, a company’s leadership, culture and staff engagement, and customer loyalty can all impact financial results. However, these aren’t recorded in financial figures.

External factors

The reason it’s important to have a regular benchmarking cadence is because changes in the economy, regulations, the consumer market or supply chains can make historical benchmarks obsolete.

For example, benchmark financial data from a period with low interest rates can quickly become out of date when the Reserve Bank of Australia raises interest rates.

Here are a few practical tips to help you get benchmarking right from the start.

1. Set clear objectives

Have a clear idea of what you want to get out of benchmarking. Do you want to increase profitability or cash flow? Or do you want to reduce costs or your company’s debt burden?

Knowing what aspect of your business’s finances you want to target helps you block out a lot of noise and focus on the most relevant data and KPIs.

2. Compare like for like 

Try to find data from businesses that are similar to yours in terms of size, growth stage, geographic footprint, customer mix and operating model. This will make for the most accurate benchmarking.

3. Set a regular benchmarking cadence

If you only benchmark for a single period, you won’t know if any performance gaps are increasing or decreasing. So make sure to have a regular financial benchmarking cadence so you can see trends across multiple periods. 

4. Use technology 

Financial management software and reporting tools can help simplify the process of collecting and preparing internal data, and normalising them for comparison to benchmarks.