Question

Discuss the three different ways a financial manager can choose a benchmark. Provide an example for each.

Answer 1

The process of comparing business growth within the whole industry in terms of process and performance is benchmarking.

There are three ways; these are as below:

1) Process: It gives the standard of business process so that the required cost should not exceed the projected benefit.

Example: Standard costing is an example of it. Material variance is part of standard costing in which material actual price is compared with standard material price. Actual price should not exceed the standard price.

2) Performance: This is the comparison between two firms in which the target firm’s performance needs to be achieved.

Example: Comparing the financial data through ratio analysis should be done here. Suppose the gross profit ratio, which is the ratio of gross profit by net sells, is a tool; if the firm’s gross profit ratio is closer to target firm’s gross profit ratio, then this is a good indicator of growth.

3) Strategic: It indicates competitors’ standpoint.

Example: Analyzing market share is an example of it. Suppose top 3 firms within the industry holds 80% market share. The remaining share, which is (100 – 80 =) 20% is for other firms. This is always good to stay among those top firms.