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The NCAA March Madness basketball tournament is an exciting time of year, where athletes compete at the highest level against long-time rivals. It is the time for teams to match their skills against their competition and vie for the opportunity to cut down the net.
It’s not too late for companies to hold their own financial March Madness. As the first quarter of 2015 is wrapping up, now is the time to evaluate your company’s performance against goals, your peer group and/or industry standards. Is your company’s first quarter performance at a level where you can compete in the Final Four?
Benchmarking is an effective tool that management can use to assess the company’s relative position or performance. It is a valuable instrument to identify areas for improvement to help businesses succeed. While different industries and companies measure success in their own ways, a few metrics are almost universally indicative of a company’s financial success.
Profitability
How much net profit does your company generate from every dollar in revenue? The net profit margin metric (net income divided by sales) is one of the most important in gauging a company’s financial health because it takes into account the costs associated with the growth of a company. An increase in sales does not always relate to a proportionate increase in profits. If you find that your profit margin is decreasing, it may indicate a need to take steps to cure the problem, such as controlling expenses.
If you are benchmarking with other companies, it is important to verify the data used in the calculation. In calculating profit margin, some competitor, peer sets or industry standards may use after-tax profits or make adjustments for owner’s compensation that exceed market rates. It is also important to benchmark within your industry as there can be tremendous variability in profit margins from industry-to-industry.
Liquidity
Liquidity measures your company’s ability to pay short-term obligations. A key metric in measuring liquidity, and often included in financial covenant requirements of lenders, is the current ratio (current assets divided by current liabilities). A current ratio over 1 is good news; however, if your current ratio year- over- year seems high, it may be an indication that you are having problems collecting accounts receivable or are carrying too much inventory.
Including inventory in the current ratio may distort a company’s short-term cash flow. Measuring the quick ratio (cash plus accounts receivable divided by current liabilities) may be a better measurement for a company’s ability to meet current obligations from assets that can be readily sold. Paired with the current ratio, the quick ratio may be a useful benchmarking tool if your company has a significant inventory balance.
Turnover
Analyzing your company’s turnover ratios provide information on the number of days your company currently holds onto cash and how quick you can turn customer accounts into cash. These ratios can highlight areas that, when addressed, may improve liquidity measurements.
The accounts receivable turnover is reported in terms of the number of days a company takes to turn accounts receivable into cash. It is calculated by taking accounts receivable divided by sales, multiplied by 365 days. Lower numbers are favorable as it is best to have cash in the bank than tied up in customer accounts.
The accounts payable turnover is reported in terms of the number of days a company takes to pay its vendors. It is expressed by taking accounts payable and dividing by cost of goods sold, multiplied by 365 days. Higher numbers are better because it means the company is able to use its cash longer.
How does your company stack up in the financial March Madness? Identify your company’s key financial metrics and complete a benchmark analysis against industry standards, your peers and/or your company goals. Each variance you identify in your benchmarking analysis provides an opportunity to improve your company’s financial performance. Clark Nuber can assist you in identifying key ratios relevant to your industry and work with you to address problem areas identified in your analysis.
This article or blog contains general information only and should not be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. Before making any decision or taking any action, you should engage a qualified professional advisor.
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