Investors who want to gauge the overall health of U.S. stocks often use major Wall Street indexes such as the Dow Jones Industrial Average and the S&P 500 as a benchmark. But these indexes also help compare individual stocks or mutual funds to see if you're making the highest return. Your mutual fund that has gained 8 percent this year sounds pretty good until you hear stocks overall are up nearly 16 percent so far in 2013, right? You might consider making a change in your investments once you know that information. At the least, you might start asking some questions to better understand the underperformance.
In the same way, using benchmarks to assess the performance of your business or its relative position can help you make decisions about your next moves - where you'll spend your capital and your effort in order to improve financial results.
Many businesses, unfortunately, have no idea how their business is performing compared with others in the industry. Their "competitive intelligence" is based on anecdotal information, such as what they hear from friends or observations about competitors' websites or storefronts.
This is helpful information, but it is not as objective or useful as having industry-specific financial data that allows you to benchmark your performance. When selecting industry benchmarks, you typically choose between data that presents the average of companies in your industry or that shows how the best-of-the-best companies in your industry perform. Either is OK, as long as you know which you are using.
In either case, make sure the industry benchmark data you use has the following characteristics so that you can adapt your strategy and operations as necessary to make more money:
It's accurate. Bad data is worse than no data, because it can send you down the wrong path and waste time and resources. Industry benchmarks should come from a large enough sample of the broader population to be representative, and they should be based on data that is collected in a consistent, objective manner. Every data set has its own eccentricities related to sources of the data, how data outliers are determined and treated, and how the sample is created, but you should know enough about these aspects to feel confident you're getting accurate data.
It's timely. You wouldn't buy a stock based solely on its performance three years ago, so comparing your business's current profit margin or sales growth to the industry using stale data doesn't make sense either. Industry data collected by the government (Census Bureau, for example) is often statistically sound, but it may not be particularly current. Whenever possible, use benchmarks in your financial analysis that are the most recent to ensure economic or cyclical changes don't skew the comparisons.
It's relevant. Comparing a tech stock's performance against that of a manufacturer is less useful than comparing it to peers in the technology sector. In the same way, business owners should seek industry data that provides the most comparable information. This could be a benchmark for the specific industry, geography or company size. While comparing your company's performance to all U.S. companies in the same industry is helpful, you may gain even more insight to know how companies in your state (facing the same tax laws and regulatory requirements) are faring. And while data on the financial performance of companies listed on stock exchanges may be easily accessible, it may not be particularly useful to compare overhead ratios for a $10 million company with a publicly traded behemoth.
Benchmarking your business doesn't guarantee that you will outperform competitors, but the competitive intelligence provided can be a good start. By using accurate, timely and relevant industry benchmarks to evaluate your own business, you'll be better able to allocate your time, energy and capital for boosting financial returns.