Industry benchmarking profit analysis is a useful and versatile tool for any business manager. Commonly used by stock analysts and large corporations, a profit analysis can be performed on a company, a market, a product or a location. The resulting analysis can be compared within a company, against specific competitors or against the industry, making industry benchmarking profit analysis a versatile and valuable tool for any business manager.
"Benchmark analysis" is a catchall term that refers to a type of financial analysis in which some variable is compared from one company to it competitors or to its industry. While common areas of interest include market capitalization, company size and innovative developments, company profit is of primary consideration. Industry benchmarking profit analysis generates a performance evaluation from a financial perspective using information found in the corporate financials; that evaluation is then compared, or benchmarked, against similar companies.
In industry benchmarking profit analysis, it is not enough to simply subtract the cost of goods sold from sales and assume that number to be the profit; rather, profit must also be reinvested in order to grow and ensure future profits. Thus, industry benchmarking profit analysis should be performed with issues of reinvestment and relative efficiencies in mind.
Put simply, this analysis is affected by several measures of profit, including sales prices, unit cost, sales volume and sales mix. Measurements of these variables can be seen in the manufacturing margin, the contribution margin, the gross profit, the throughput and the net income.
Industry benchmarking profit analysis may not be a solution for all problems facing the performance manager, but it’s value cannot be undermined. When used correctly, it can provide an objective view of the financial performance of a company. While this type of analysis is used in-house to determine areas where improvement is needed, it is also frequently used by stock analysts and in company valuations.
Benchmarking is an analysis tool that should be used with caution because it uses general averages. Even between companies with comparable averages, there are many variables, both tangible and intangible, that can make a company succeed or fail. All too frequently, people will perform a benchmark analysis without a fair conception of what variables would produce the most accurate benchmark.
Likewise, it is generally useless to compare benchmark performance between industries; for example, a technology company will have a higher profit margin than an industrial machinery manufacturer because fewer materials are required. Taking a similar example, a software company cannot be compared apples for apples to a computer company.
Benchmarking analysis should only be used when the analyst has a thorough understanding of the important variables particular to his company and has the ability to identify like companies. It should always be used in context.
One common misconception is that only stock analysts and large corporations use industry benchmarking profit analysis. Due to its effectiveness when correctly applied, many small businesses are now applying industry benchmarking profit analysis, both historically and against competitors.
Another common misconception concerning industry benchmarking profit analysis is that the indicators of performance will be the same for all companies within an industry. Performance indicators are highly specific and should not be generalized. In fact, many companies get themselves in financial trouble by not carefully evaluating what performance indicators should be monitored.
- Use Benchmarks with Care; Chris Burand; 2006
- Management Accounting; James R. Martin; 2007
- Profitability Analysis; Mohsin Y. Meghji; 2002