Question

What is benchmarking and what are the two main types of benchmarks in financial statement analysis?

Answer 1

Answer:

It is important to measure performances of company's processes against a standard/target. The practice of setting standards of measurement values based on leading company(ies) in the industry and comparing process measurements against such standards is benchmarking.

In financial statement analysis, we calculate various liquidity ratios (like current ratio, quick ratio) , activity ratios ( like inventory turnover, receivable turnover, asset turnover etc.) , profitability ratios ( like Net Margin, Gross Margin, Return on equity etc.) and Leverage ratios (like Debt to equity ratios). For benchmarking, we get the measurement values of leading company(ies) in the industry and set benchmarks and compare our values of financial ratios to such benchmarks. For example, if our inventory turnover ratio is 4 and benchmark is 8; this should trigger an analysis to get root causes for difference and areas where we need to improve.

There are two types of benchmarking:

Benchmarking against inductry

Benchmarking against a key competitor.