Benchmarking as a service in CAAS practice
By Wendy Li, CPA
“If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle.”
– Sun Tzu, The Art of War (translated by James Clear)
What a great quote to introduce benchmarking as a service in the Client Accounting and Advisory Services (CAAS) practice!
What is benchmarking?
Benchmarking is the process of measuring the products, services, processes and financial performance of one company against those of similar companies and the industry standard.
Effective benchmarking services provide companies with detailed self-understanding, in the form of knowledge about how their key performance indicators match the economic ecosystem within which the company operates — whether they are taking full advantage of opportunities for growth — and detailed understanding of how competitors are doing in the same system.
Should we add benchmarking to our CAAS practice?
CAAS practices typically provide services that can be categorized into three tiers: bookkeeping services, accounting services and part-time controller services. These services assist the company with recording the past, analyzing the present and planning the future. But what about other companies’ performance within the industry? A 10% growth rate seems good, but would your opinion change if you knew that your competitor has 30% growth, and the industry rate is 25%? Wouldn't knowledge like this be empowering?
Your clients need to know where their companies stand in the industry and how the financial metrics of their peers compare, to improve business processes, product quality and customer satisfaction. Benchmarking provides these insights.
What benchmarking services can we provide?
Benchmarking can be a complex process, but we don’t need to offer every service to every client. When the time is right, we can introduce benchmarking services one step at a time. Taking things slowly allows us to tailor services to client needs.
Let’s start with financial performance benchmarking. Since we have most of a client’s financial data, we can save time on data collection and go straight to mapping the data to the model for financial metrics/key performance indicators (KPIs) for financial performance.
Practice benchmarking is a comparison of products, services, processes and methods to competitors. We can gather and compare qualitative information through research, questionnaires, surveys and conversations.
Internal benchmarking is the internal comparison of departments, units, product lines, services, etc. within a company. If a client wants to find out which product or service is more profitable or which department is more productive, internal benchmarking is recommended.
Determine what is critical to the company’s success, what problems they are facing and what needs an urgent fix by designing a survey or questionnaire around those concerns. If simply communicating with the accounting or financial department is insufficient, then human resources, operations, business development and/or the marketing department should be involved as well. After performing a benchmarking analysis, it is important to follow up with the client to monitor any changes and improvement and decide if further analysis or additional services are needed.
How do we perform benchmarking and what do our findings mean?
We work with clients in various industries and by relying on our benchmarking analysis model, we can compare our clients to others in the same industry, using standard benchmarks. This comparison helps clients understand their specific situation and provide improvements and solutions to problems that are uncovered. For example, we recently compared four client staffing companies by calculating their 2020 KPIs and financial metrics, and comparing them to industry benchmarks. These four companies were medium size by revenue ($5 million–$50 million), and we focused on nine financial metrics:
- Quick ratio: This ratio measures a company's ability to meet short-term obligations with liquid assets. The higher, the better; a number below one signals financial distress. The employment service industry benchmark was 1.3. The four companies we studied all performed better than the benchmark with quick ratios between 1.43 and 1.99.
- Current ratio: This ratio also measures a company’s ability to meet short-term obligations; however, while the quick ratio considers only assets that can be converted to cash, the current ratio also considers inventory and prepaid expense assets. A current ratio between 1.5 and three is considered healthy, a ratio lower than one may indicate liquidity problems and a ratio over three may indicate that the company is not using its current assets efficiently or not managing its working capital properly. The industry had a ratio 1.57 and the four companies we studied had ratios between 1.48 and 2.02, indicating a healthy condition.
- Current liabilities to net worth: This ratio indicates the amount due to creditors within a year, as a percentage of stockholders' equity in a company. A high ratio (above 0.8) can indicate trouble. The whole industry had a high benchmark of 0.97 and the four companies we studied had even higher ratios, between one and 2.04, indicating their equity couldn’t cover their current liabilities due within a year.
- Days accounts receivable or days sales outstanding: This is a measure of the average number of days it takes a company to collect payment for a sale — the fewer the days, the faster the collection. The four companies we studied all took much longer (between 53 and 83 days) than the benchmark of 50 days to collect sales payment. This is an area in which they all need to improve.
- Working capital turnover: Also known as working capital to sales, this measures how efficiently a company uses its capital to generate sales and support growth — the higher, the better. The industry benchmark was 11.9, meaning one dollar of working capital produces $11.9 in revenue. The four companies we studied had ratios between 5.83 and 10.85, indicating low efficiency of using short-term assets and liabilities to generate sales.
- Total assets to sales: This ratio helps determine the company’s efficiency in managing its assets to generate enough sales. The benchmark ratio was 36.1%, and three of our client companies performed very well with ratios between 28.43% and 31.49%, while one company had a very high ratio of 45.34%, indicating a low efficiency in asset management.
- Pre-tax return on sales: This is also called pre-tax profit margin, a financial accounting tool used to measure the operating efficiency of a company. It indicates the percentage of sales that have turned into profits before deducting taxes. While the industry had a very low ratio 0.8%, the four companies we studied surpassed the benchmark with performance ratios between 4.6% and 8.88%.
- Earnings Before Interested, Taxes, Depreciation and Amortization (EBITDA) to sales ratio: Also known as EBITDA margin, this is a financial metric used to assess a company's profitability. A higher value indicates the company can produce earnings more efficiently by keeping costs low. Given the industry benchmark of 5.5%, three out of four of our client companies were doing very well with ratios between 7.07% and 9.05% and the company that underperformed still had a ratio 4.95%.
- Interest coverage: This is a debt and profitability ratio used to determine how easily a company can pay interest on its outstanding debt. The higher the ratio, the better prepared it is to pay its debts. A lower ratio may be unattractive to investors because it may mean the company is not poised for growth. The industry had 2.63 interest coverage and the four companies we studied overperformed, with ratios between 10.44 and 89.55.
Based on our benchmark analysis, we learned that all four of our client companies had the ability to meet their short-term obligations and utilize their current assets efficiently and properly. However, some KPIs and metrics indicated red flags in areas that need improvement.
- Current liabilities to net worth: All four companies could not use their equities to pay off their current liabilities due within a year, which impacts the company’s ability to borrow, as it is a key ratio that banks use to evaluate risk. To improve financing ability, companies should try to pay off vendors earlier and generate more profits down the road.
- Days accounts receivable: To speed up the collection of receivables, companies should consider:
- Standardizing procedures for product or service quotation and order management.
- Getting electronic invoices out faster.
- Outsourcing collections.
- Adjusting credit terms based on customer history.
- Working capital turnover: The four companies we studied didn’t manage their working capital efficiently to support revenue. Our suggestions for improvement are to:
- Shorten operating cycles.
- Cut unnecessary expenses.
- Reduce bad debt.
- Generate more revenue.
- Balance cash reserves against accounts payable.
After analyzing the data, we discuss this with the client and propose a benchmarking report. If the client is interested, a deeper, more extensive benchmarking report can be provided.
Adding value for your clients
In competitive environments, success comes from understanding oneself and competitors as fully as possible. Benchmarking services empower our clients with the knowledge necessary to make strategic business decisions, and as their trusted advisers, we can help our clients achieve growth and improve profitability by offering more than just the typical suite of CAAS services. Accounting firms have a broad client database, tech stack, experienced professionals and research and analysis tools at our disposal. As we are helping clients with traditional CAAS services already, going one step further to offer benchmarking analysis can add value for our clients and strengthen our long-term relationship.
Wendy Li, CPA, is a supervisor at CRR, LLP. You may reach her at email@example.com.
Reprinted with permission from the Massachusetts Society of CPAs.