Keeping Score (Part 1)
by CFOEd
Click here for the SmartSamantha Industry Insight SmartCard
How does your business's financial performance stack-up? In this Bizdom, we explore how to use industry financial norms, or scores, to answer this question and identify areas of opportunity. In Keeping Score(Part 2), we examine these scores for a variety of industries, why they vary and how to use this knowledge to make better decisions.
Keeping score is an important part of our personal lives and in business. We keep score in tennis – games won in a set, and sets won in a match, like 6-4, 5-7, 6-2. Hopefully, you won the 1st and 3rd set. Grade Point Average (GPA) is one score kept in school to measure how well a student is performing. A GPA of 3.5 indicates a student is doing better than one of 2.5, holding all else the same.
We keep scores in our personal lives to measure how we are doing relative to others, our progress over time and identify areas for improvement. And we do the same in business, but here the scores are how our business benchmarks over time to others in our industry for areas like customer satisfaction, financial performance, employee performance, etc.
The main business game usually focuses on the firm’s financial perspective—or how the business scores on the four key drivers of performance:
- Revenue growth – year -over-year percentage growth in revenue.
- Profitability – profits expressed as a percentage of revenue.
- Asset utilization – how much is invested in assets per dollar of revenue.
- Return On Assets – profits earned relative to the total investment in operating assets.
Knowing financial scores and how they stack-up is important for a number of reasons—and one is capital acquisition. Donna Kain, President of the Private and Entrepreneurial Banking Division at Buckhead Community Bank in Atlanta, Georgia notes, “When considering a loan request, I often compare the company to industry norms. This gives me an idea of how well or how poorly they are managing the business, which is an important part of the credit decision. Standards vary by industry. Before approving a loan, I think about what are the business factors causing a company’s ratios to vary both higher and lower from the industry norms and what are the implications for their ability to repay a loan.”
The SmartSamantha Industry Insight SmartCard reports the financial performance scores for a variety of industries. The Smartcard reports each industry’s ranking relative to all the industries. The bottom of the SmartCard reports each score’s:
- Median - an an indicator of how the industries are performing overall.
- 1st Quartile - how the industries in the top 25% are performing.
- 4th Quartile - how the industries in the bottom 25% are performing.
Insight: Managing a low-margin business may still produce a good return if it has better than average asset utilization. On the other hand, a very profitable business may look attractive at first, but if it has poor asset utilization and, as a result, a low return, then something needs to be changed. You must remember to take a balanced view as a business’s return on assets is driven by both profitability and asset utilization.
The Industry SmartCard insights help illustrate this. For example, it shows that most industries in Services – Business sector:
- Have revenue growth and asset utilization scores in the top 25% (the same or better than the 1st quartile) as indicated by the green arrows. Not bad!
- However, profitability is a mid-range performer (between the 1st and 4th quartile) as indicated by the yellow arrow.
- But let’s not forget that profitability combined with asset utilization determines return. The Services - Business sector provides superior returns – they all have green arrows – because better asset utilization more than compensates for its mid-range profitability!
Use the SmartSamantha Industry Insight SmartCard for your own insights into the following questions:
- How do my scores compare to the industry? In what areas do I have a competitive advantage and what are potential areas of improvement?
- What is the expected return from growing the business? How does this compare to the return from alternatives?
- As I grow the business, how much will I need to invest in incremental assets? How much of this will come from internally generated funds and how much will I need to raise from outside investors?
- When I seek outside funding, if my scores deviate from industry norms (either lower or higher), what is the business logic? How will I be able to explain this since I know creditors and investors will look at these and ask questions?
- Are there other industries that compliment my existing business into which I can expand that have good growth and return?
So click over to the SmartSamantha Industry Insight SmartCard to see if your company is in balance with your industry.
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