Industry Financial Ratio Benchmarking for Small Businesses 101: Tips for Business Owners and Bankers

by Carly Edmondson, Senior Manager, Credit Products

financial statement benchmarking

A recent article in the Springfield Business Journal points to “uncontrolled growth” as one of the main reasons why small businesses fail. The author states that “It is common for business owners to inaccurately assess opportunity,” then unpacks this idea in relation to market needs, vendor partnerships, cash flow, and timing. To combat inaccurate assessment, the author recommends industry financial ratio benchmarking as a solution.

Benchmarking for small businesses can be difficult for a few reasons. First, every business is fairly unique in its composition, geography, industry, and goals, making it hard to find a true apples-to-apples comparison. Second, if the business serves a niche market within a particular industry, it can be even more challenging to get your hands on any useful financial data. Finally, most small businesses do not have the resources to research and gather all this data as they are consumed with running the day-to-day operations.

For small business owners and the commercial bankers who serve them, one solution for industry financial ratio benchmarking is RMA’s Annual Statement Studies, which offers the most trusted source of comparative benchmarking data to help determine how a business’s financials compare to peers on average. Read on to explore a few of the benchmarking metrics available for over 700 industries in Statement Studies and how to use them in your analysis.

Three Types of Metrics to Guide Small Business Owners

Small business owners should analyze the following Statement Studies metrics to measure performance and, in turn, make decisions that improve business efficiency:

  1. Operating Metrics
    • Gross Profit Margin
      • A lower-than-average gross profit margin may be an indication that you are charging too little for products or paying too much for inventory or materials. When you’re first starting out, comparing your gross profit margin to Statement Studies can help you figure out what kind of mark-up is most appropriate.
    • Operating Margin
      • A higher number indicates a company is performing well. If your gross profit margin is strong, but your operating margin is below average, consider reducing or rearranging expenses to improve your profitability. The operating margin metrics in Statement Studies can also be invaluable in budgeting for your year, and banks look at profitability metrics to determine if your company generates enough profit to service debt obligations.
    • Change in Net Sales
      • If your company’s change in net sales is significantly lower than peers, you may need to make changes to product mix, pricing, or seek out other strategies for increasing sales year-over-year.

  1. Liquidity Metrics
    • Days Receivables (Sales/Receivables Ratio divided by 365)
      • Generally, the greater number of days outstanding, the greater the probability of delinquencies in accounts receivable. If your company’s days’ receivable are significantly higher than average, you may want to look at your collection process and work to collect receivables on a more timely basis.
    • Days Payables (Cost of Sales/Payables divided by 365)
      • The higher the turnover of payables, the shorter the time between purchase and payment. If your turnover is lower than the industry average, you may have leverage to seek out extended terms.

  1. Leverage Metrics
    • Debt/Equity (Total Liabilities divided by Shareholders’ Equity)
      • A low debt-to-equity ratio in Statement Studies may indicate that peer companies are typically funded with more shareholder funds than debt. Banks will also commonly look at this metric to determine creditworthiness. Red flags are raised when a company’s debt/equity ratio is too high. 

Four Types of Metrics that Bankers Evaluate

Bankers frequently analyze the following Statement Studies metrics to evaluate a business’s creditworthiness, so small business owners should certainly be aware of common benchmarks for these metrics even if they don’t necessarily drive business decisions:

  1. Operating Metrics
    • % Profits Before Taxes/Tangible Net Worth and % Profits Before Taxes/Total Assets
      • Both are indicators of management performance and express how efficient and well-capitalized a company is.
    • Net Cash after Operations
      • This ratio reflects the amount of cash available for servicing interest on bank debt. In other words, it adjusts the cash after operations to reflect net cash outflows or inflows arising from changes in income taxes and miscellaneous assets and liabilities.
    • Sustainable Growth Rate (SGR)
      • Sustainable Growth Rate is a single number representing the annual percentage increase in sales that is consistent with a stable debt and capital structure (i.e., where total debt/net worth ratios do not change significantly or materially, from year to year). If a company’s sales expand at a rate greater than the SGR, the company’s debt/worth ratio will rise and result in an “out-of-equilibrium situation.” When this happens, the firm approaches an over-leveraged position that raises the possibility of liquidity and debt repayment problems.
  1. Liquidity Metrics
    • Current Ratio
      • Generally, the higher the current ratio, the greater the "cushion" between current obligations and a firm's ability to pay them. While a stronger ratio shows that the numbers for current assets exceed those for current liabilities, the composition and quality of current assets are critical factors in the analysis of an individual firm's liquidity.
    • Quick Ratio
      • Also known as the "acid test" ratio, this liquidity measure is stricter and more conservative than the current ratio. This ratio reflects the degree to which a company's current liabilities are covered by its most liquid current assets, the kind of assets that can be converted quickly to cash and at amounts close to book value. Inventory and other less liquid current assets are removed from the calculation. Generally, if the ratio produces a value that's less than 1 to 1, it implies a "dependency" on inventory or other "less" current assets to liquidate short-term debt.
    • Days Payables
      • If a company's accounts payables appear to be turning more slowly than the industry, then a bank may assume the company is experiencing cash shortages, disputing invoices with suppliers, enjoying extended terms, or deliberately expanding its trade credit.
  1. Coverage Metrics
    • Net Cash after Operations
      • This ratio helps a banker determine whether a business can meet all its operating needs and has sufficient funds remaining to meet principal and interest debt-service requirements and to cover dividends. If the ratio is less than 1:1, it indicates a company must borrow funds to meet some or all of its financing obligations.
    • Earnings Before Interest and Taxes (EBIT)/Interest  
      • This ratio measures a firm's ability to meet interest payments. A high ratio may indicate that a borrower can easily meet the interest obligations of a loan. This ratio also signals to a bank a firm's capacity to take on additional debt.
    • Net Profit + Depreciation, Depletion, Amortization/Current Maturities Long-Term Debt
      • This ratio reflects how well cash flow from operations covers current maturities. Because cash flow is the primary source of debt retirement, the ratio measures a firm's ability to service principal repayment and take on additional debt. Even though it is a mistake to believe all cash flow is available for debt service, this ratio is still a valid measure of the ability to service long-term debt.
  1. Leverage Ratios
    • Funded Debt/EBITDA
      • As the calculated ratio grows larger, a borrower is likely to have more difficulty in meeting its debt obligations.
    • Fixed/Worth
      • A lower Fixed/Worth ratio indicates a proportionately smaller investment in fixed assets in relation to net worth and a better "cushion" for creditors in case of liquidation. Similarly, a higher ratio indicates the opposite situation. The presence of a substantial number of fixed assets that are leased - and not appearing on the balance sheet - may result in a deceptively lower ratio.
    • Debt/Worth
      • This ratio essentially demonstrates how much protection is provided to creditors by the owners.  The higher the ratio, the greater the risk a firm will be assumed by creditors. A lower ratio generally indicates greater long-term financial safety. Unlike a highly leveraged firm, a firm with a low debt/worth ratio usually has greater flexibility to borrow in the future.

How to Get the Access to Reliable Industry Benchmarking Data

For over 100 years, RMA’s Annual Statement Studies has been the only, most trusted source of comparative industry benchmarking data for small businesses and the lenders who serve them. Using this data and the insights above, you have everything you need to make better decisions for your business or bank.

To learn more about the ratios, how they are calculated, and what they look like for your industry, download a Statement Studies individual report now and be sure to use a bundle code if you need three or more reports. And if you need data for more than a couple industries, subscribe to eStatement Studies, subscribe to eMentor, or buy the book to access all 700+ industries available via Statement Studies. 



Carly

As a Senior Product Manager for the Business Solutions team, Carly is responsible for the vision and execution of the eMentor product, which includes access to Statement Studies, industry reports and training resources. Prior to joining the Business Solutions team in October 2020, Carly was a Relationship Manager for RMA in the South Central region. Carly holds a B.S. in Finance from the Tulane University and is based in Dallas, TX.


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