How do you know you are successful and secure? This is a loaded question that would result in an infinite number of responses in a poll. Success and security are both very personal. Author Earl Nightingale defined success as the progressive realization of a worthy goal or ideal. Security may conjure up feelings of comfort that you are protected from future uncertainty.
In the realm of finances, success and security are generally associated with the feeling that you have enough to provide for all of your needs and many of your wants with little worry that your status will change in the future. Most of us will never reach a point where we live with zero financial worries because most circumstances can easily change.
Change is a certainty, and it is best to arm ourselves with tools, like benchmarking, that can help us anticipate or endure challenges ahead. Action through tracking can go a long way to ease financial worries and get you closer to knowing that you are successful and secure.
What is benchmarking?
Benchmarking is the act of comparing a performance metric against a standard or trend. The performance metric can be compared to that of an entity that is achieving the success desired. Another healthy way to benchmark is to compare the metric to oneself over time to spot positive or negative trends. Spotting changes in performance metrics could lead to a proactive versus reactive approach to inevitable changes.
Each organization should determine which performance metrics are their key performance indicators (KPIs). KPIs are the performance metrics that are most essential for each entity. Different business types have different KPIs that can be tracked through benchmarking. Some KPIs are standard like financial ratios (e.g., gross profit margin and current ratio) that can be calculated and tracked over time, and some are specific, like the price per thousand board feet of oak for a sawmill.
Standard financial ratios
Standard financial ratios are calculations that can be done for most businesses and compared to an industry standard. They can include liquidity ratios, profitability ratios, and funds management ratio among others.
Liquidity ratios are important because they measure a company’s ability to pay debt obligations in the short term. Many times you must pay up front for supplies for a project before you are paid, which can create cash flow problems. The current ratio is a popular liquidity ratio that is calculated by dividing current assets by current liabilities (i.e., things due to be paid soon).
According to IBISWorld, a company that does industry and market research, “the industry of flooring installers in the United States current ratio for April 2016 – March 2017 was 1.7. Over this same timeframe, the current ratio was 1.8 for small companies (less than $10 million in annual revenue), 1.6 for medium companies ($10-50 million), and 1.5 for large companies (over $50 million).”
If you have $145,000 in current assets (e.g., cash, accounts receivable) and $80,000 in current liabilities (e.g., current payment due on loan, bills due soon), then you have a current ratio of 1.81 and are right in line with most flooring installers making less than $10 million a year.
A simple profitability ratio that most companies track very closely is the profit margin. This is profit divided by sales during a given time period.
IBISWorld goes on to say that, “industry profit, defined as earnings before interest and taxes, fluctuates with cyclical patterns of investment in the downstream building markets and the price movements for materials and labor. The unprecedented slump in demand from the downstream construction market severely narrowed the industry’s margins during 2012 even after recovery was underway. After subsequent years of recovery, IBISWorld estimates that the average industry profit margin, where profit is defined as earnings before interest and taxes, accounts for 5.5 percent of revenue, up from 3.9 percent in 2012.”
Compare your profit margin each month, quarter, or time-frame that works for your company. You could put the data in graph form to easily visualize how you are doing over time. This can help you make changes in your operations including quoting for business or finding ways to cut costs to get the profit level back in line with where you need it to be to
have success and security.
A funds management ratio that is important for most industries is the trade receivables turnover and days’ sales in receivables. Calculate your trade receivables turnover by taking sales for a time period by the average receivables during that same time period. If your trade sales for a year are $2 million and on average you have $300,000 owed to you from customers, then your trade receivables turnover is 6.7 and is in line with the 6.9 published in the IBISWorld flooring installers report for small businesses.
Take 365 (the number of days in the year) divided into your trade receivables turnover of 6.7 to come up with the average days’ sales in receivables. That would be 54 days in this scenario. Track this over time to see if you compare to the industry average and yourself over time. You could also track it more often (i.e., monthly or quarterly) to spot times of the year when your numbers fluctuate. You could be proactive during those times to work with customers to pay more timely or simply know it’s coming to finance your operations during those times.
Not all key performance indicators are financial. Many are related to your operations. Try looking at customer satisfaction. Find a way to rate a customer’s satisfaction on a scale and compare that over time. As customer satisfaction rises, so will your success in other areas of your business. What other nonfinancial indicators result in success for you?
NWFA provides members with the executive summary of the Catalina Report for free as a membership benefit as well as a $400 discount on the purchase of the entire study. According to Catalina Research, “This in-depth analysis indicates how the $3.8 billion wood flooring industry has penetrated the builder and residential replacement markets over the past decade. Data trends on species, pricing, residential and commercial markets, retail distribution channels, and customer demographics give wood flooring manufacturers and marketers information to develop strategies that allow them to make further inroads in the U.S. floor coverings industry.” Take advantage of this and other industry trade reports to spot potential KPIs or trends that will impact your business.
Keep in mind that some indicators are lagging and some are leading. Lagging indicators are typically measured by past data while leading indicators are input oriented and can predict something in the future. Both are important, but finding a good leading indicator to track can lead you to better decision making that can make you more successful and secure in the future. One leading indicator in the wood flooring industry might be housing starts. More housing starts typically result in more wood flooring purchases in the near future.
Don’t forget other ratios or metrics that might be specific to you or your location. Ask friends in the industry what they track. Determine which operational and financial performance metrics result in the most impact on your success, then track those on a dashboard at regular intervals.
Your benchmarking process can evolve over time as you get more experienced with tracking. KPIs can also change for the industry overall, so don’t think of adjustments to your process as a failure. Many great businesses have failed due to their lack of ability to accept change. Ultimately only you can determine what success and security look like for you. If you are tracking well against your own values in life, you are successful.
Bree Urech-Boyle is Chief Financial Officer at the National Wood Flooring Association in St. Louis. She can be reached at firstname.lastname@example.org.