Do you know how you compare to your competitors? Everyone knows it's important to track how your business is doing compared to past quarters and years. Yet it's equally important to have an idea of how your business is doing compared to the competition. For instance, if you have a 10 percent net profit, is that good or bad? My response would be that it depends. It depends on the history of your business, as well as how other businesses in your industry are doing.
The information you need to evaluate includes things like gross profit ratio, net profit ratio and current ratio. Of course many other ratios exist, but those are a few key ones you should begin with. Here's what they mean:
- Gross profit ratio is calculated by taking your income less your direct materials and labor costs (i.e. cost of goods sold) to derive your gross profit in dollars. This amount is then divided by your total sales to give you your gross profit ratio.
- Net profit ratio is calculated by taking your gross profit in dollars less your overhead expenses to arrive at net profit in dollars. This amount is then divided by your sales income to give you your net profit ratio.
- Current ratio is calculated by taking your current assets divided by your current debt to help you determine how liquid your business is. For instance, are you able to pay your short-term obligations with liquid assets?
Now that you know what to look for, here are ways you can find out this type of industry information and use it for valuable comparisons in your management reviews.
- Industry associations--Visit with your industry association. They often publish industry information on their members of various sizes, as well as general financial comparisons.
- Business library--You can also find ratio and industry information at your local business library. Using your library can be time consuming, but there often is no cost involved.
- Online web resources--With the great amount of information available at our fingertips, you can find virtually any figures you want. Various website provide the information you'll be looking for, but most charge a fee. Just search for a term like "industry ratios," and you’ll be able to assess your options from there.
- Banker--Visit with your banker. If you have an established banking relationship, your banker can be an invaluable resource. They look at ratio analysis data all the time when determining credit worthiness. So let them share their valuable insights with you about how your business compares to others in your industry.
- Management accountant--Your management accountant is another great resource. This area is their specialty and they can use their professional insight to provide guidance on how you can improve your ratios and make your business more profitable and credit worthy.
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These last two options are at the top of my list because you're getting the professional insights of an actual person. When you look at the ratios, do you know what they mean? Most likely not, which is where it pays to have a professional on your team helping you learn the key indicators of your business. So make sure you know how your business is doing, not only compared to your past data, but also compared to your competitors.
Pam Newman is Entrepreneur.com's "Financial Management" columnist and president of RPPC Inc., which helps entrepreneurs succeed in their businesses through small-business training and consulting services in the areas of accounting and management. She's also the author of Out of the Red, a management accounting guide for small-business owners.