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Financial Ratio Bench-marking provides important key performance indicators (KPI's) in any business.They often give a sharper focus for key strategic planning areas of the business.
They play a very important part of the overall business reporting template at senior levels in any organisation. Hence they will rely very heavily on good accounting information.
Through alternative methods of financial ratio analysis there are several ways to develop this topic of bench-marking .
It is important though to recognize that financial or accounting ratios although important, are certainly not the only key part of an overall organisations performance reporting.
Other important bench-marking areas apart from financial bench-marking in business, will need to be included for customers, people and processes.
This tutorial will however just concentrate on finance and those relevant to financial statement analysis of a balance sheet example or pro-forma income statement.
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If you prefer to read rather than watch the video here is a summary transcript:
“The key learning points from this tutorial will be: what bench-marking really means; ways to use it in the business; and how it can be easily used to help understand and also improve performance.
A very important concept in financial ratios is to understand that a financial ratio on its own can tell us a little about a business, though maybe in itself it does not tell us a lot about the business.
So, how do we get these ratios to tell us even more? This is where the concept of bench-marking comes in. So, as we mentioned earlier, there are three options: firstly, similar business bench-marking; secondly, past periods; and thirdly, future periods.
Let's firstly have a look at similar business bench-marking. What this means, it could be a very close competitor or maybe just a similar business who for whatever reason, maybe because it's in a different territory, is not in direct competition but is a business that lessons could be learned from.
Another maybe more macro indicator rather than just one single competitor may be to look at the industry average for the sector. In order to get the best out of bench-marking against a similar business, it's wise to be aware of the limitations when using these types of similar business benchmarks.
For example, in this particular case, have a look at the trading conditions. Are the accounts that you're looking at showing trading conditions that have got the exact same year end or are there different year ends?
So, seasonality may come into play. Have a look and be aware of the different accounting policies, how can they impact on the figures that you are looking at?
Sometimes it may just simply be not easy to get any financial information on a competitor.
Another type of commonly used bench-marking is bench-marking for past periods. So, how can this help an organisation? Well, this can help an organisation in many ways. Firstly, it can help an organisation measure trends, so a business can look at a weekly trend, a monthly trend or an annual trend.
You could also explore this a little bit deeper by having what are called trend combinations, so not only do you look at trends within the business, you can also compare and contrast the internal historical trends within the business to the historical external trends of an industry average or maybe other competitor.
This brings us onto the third way in which we can use these benchmarks very cleverly. So, the last slide showed us gross margins that were rising which look good but they're behind the industry average.
So, what we can now devise is a future period target for the business to reach the industry average and this could be, for example, over the next three years.