Question

What is benchmarking, and what are the two main types of benchmarks in financialstatement analysis?

Short answer

The practice of setting standards of measurement values based on the leading company in the industry and comparing process measurements against such standards is benchmarking.

Step-by-step solution

Step 1:Meaning of Benchmarking

An important measure or practice that a company follows to compare the performance of a company's processes against a standard/target set up by the industry is known as 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 companies in the industry, set benchmarks, and compare our values of financial ratios to such benchmarks.

For example, suppose our inventory turnover ratio is four, and the benchmark is 8. In that case, this should trigger the analysis to get the root causes for the difference and areas where we need to improve.

Step 2:Two types of Benchmarking are

1. Benchmarking against industryand
2. Benchmarking against a key competitor.