Question

What is benchmarking and how does it impact horizontal and vertical analysis? Provide an example.

Answer 1

Benchmarking is the process of comparing or measuring a company's performance against the performance of other companies whose performance is considered as the standard or benchmark.

In horizontal analysis, we compare the company's performance in the current year with the past years' performance. For example, Royal Enfield sold 20 lakh bikes in the current year 2020 compared to 10 lakh, 12 lakh, 15 lakh and 18 lakh sold in 2016, 2017, 2018 and 2019 respectively. But such analysis would not be helpful if we do not compare Royal Enfield's sales figures with the leading company in the industry suppose Triumph's sales figures. Thus benchmarking is a useful additional tool in horizontal analysis.

Similarly in the vertical analysis of financial statements where we take the help of a base to measure the financial performance. In this case too, benchmarking helps to compare the various items of the financial statements such as assets and liabilities of two or more companies. This will help a company in our example, Royal Enfield to distinguish the percentage increase or decrease in the items of the income statement and balance sheet when compared with Triumph's financial statements.