Benchmarking strategy vital to business performance.

What company sets the standards in your industry, and what can you learn from them? Many executive teams sit around the conference table, beginning the budgeting process for the fiscal year and comparing their performance from year to year. That is a good start--but it is not enough in today's economy.

It is necessary to look at internal, as well as external, standards. The ultimate goal of benchmarking is to utilize actual peer operating results to improve the performance of all business processes, including production, purchasing, accounting and customer service.

Research demonstrates that performance in these areas can be improved by 18 percent through benchmarking, according to the Trendsetter Barometer, a quarterly survey of CEOs sponsored by PricewaterhouseCoopers. These are not just speculative questions--the answers form the foundation upon which you can build a benchmarking strategy for your enterprise.

An executive team that reduced the cost per full-time equivalent employee from $37,000 to $34,750 might be pleased, but not as happy as it might be. If it had compared the company's costs to industry standards, it might have discovered that the average cost per full-time equivalent employee in its field was $32,000.

Finding the relevant data--for the purpose of comparison and contrast--is the first step in benchmarking. Potential resources include trade groups, federal or state governments and even benchmarking Web sites. For example, AMMBIT (Advanced Middle-Market Business Intelligence Tool) is a benchmarking tool developed by PricewaterhouseCoopers. This interactive tool provides private companies access to aggregated high-quality and hard-to-find operational and financial performance evaluation data on more than 3,500 U.S. company datasets in more than 230 industries.

Once you have the data source, you must determine which metrics are most important for your business. These might include activity ratios like receivable turnover, inventory turnover, days sales outstanding (DSO), gross margins, income from operations as a percent of sales or net income as a percent of sales.

You should use a number of small metrics--from three to five--at any given time. Using too many metrics might make the process overwhelming. When first starting the process, in fact, you may want to use just one metric.

For example, a retailer named, XYZ Corp. decides to examine its metric of DSO to assist XYZ's finance team in determining the efficiency of its overall credit policy. This is calculated by dividing sales by average accounts receivable and by dividing that result into 365 days. If XYZ's DSO is 62 days in the current year and is down from 65 the previous year, it might think the company is doing well. However, if XYZ's CFO discovered through benchmarking that the leading companies in her industry had DSOs of 45, she would know that some improvement was needed.

This difference is commonly called the "performance gap." There will be reasons why your company is performing well below the standards set by the leaders in your field. To narrow this gap for DSO, you should look at the key areas of receivables management, collection, credit approval and invoicing:

* Receivables Management. Make sure the executive in charge of accounts receivable is utilizing industry best practices, like linking sales compensation to cash collected, not sales invoiced. He should also review payment terms when negotiating with new customers, and set goals to improve billing accuracy and timeliness.

* Collection. Ensure that your sales representatives are involved in the collection process. They should stay on top of past-due accounts.

* Credit Approval. Conduct credit review on existing customers, as well as new customers. The credit department should not only ask for references, but check them.

* Invoicing. Mail invoices promptly. The invoices should clearly show payment terms and specify penalties for late payment. Problems should be addressed quickly, ensuring that the same errors are not repeated.

A $50 million distributor with a DSO of 62 would have about $8.5 million in accounts receivable. Each one-day reduction in the DSO generates an additional $137,000 in cash flow. What's more, improving the DSO by 10 days will produce an added $1.4 million in cash flow, which creates an additional revenue stream to pay outstanding debts or purchase newer productivity-enhancing equipment or software.

Benchmarking is not a one-time project. Once you have succeeded with one metric and improved your company's performance, you can benchmark other metrics. Because this is a perpetual process to gauge strengths and weaknesses, benchmarking will cultivate the implementation of industry best practices. This will reduce any other performance gaps your company may have and help you lead the field.

Thomas Angell, CPA, is a principal with Rothstein Kass (www.rkco.com), a Top 20-ranked international accounting and consulting firm. He can be reached at 973.994.6666 or [e-mail].