Internal Benchmarking: Use Past Performance to Boost Future Profit

Would you like a proven profit improvement technique that's simple and requires neither outside consultant nor third-party tool nor report nor MBA degree? We've got it: internal benchmarking.

Internal benchmarking is a simple method to determine your company's profit potential. All you need is your own historical annual income statements. By analyzing each statement, line by line, you can identify the best historical performance by line item or department. You then can use the information to work toward putting all of your best line-item performances into future years. The result will be a vastly improved bottom line.

The logic is simple. Your bottom-line profit is what's left over after all the expenses have been paid out of revenue. So why not focus on each line item? If each is managed to hit a desirable target, the bottom line will take care of itself.

Here's How

To show you how, let's walk through an internal-benchmarking analysis for Chester Fields Corporation (CFS). We gathered the most recent five full years of income statements for CFS and lined them up, side by side, as in the table on page 4 titled CFS Internal Benchmarking Worksheet. We created it by loading income statement data, by hand, into Excel. We added percentage fields ourselves, too. Each year's percentages are calculated with total revenue as the denominator.

Due to space limitations, we used summary income statement data. Of course, you can go into as much detail as you wish.

Analyzing the spreadsheet, we identified and circled each line item when it was at its most favorable. Then in the far-right column (i.e., the pro forma "best of" income statement), we plugged them in. For revenue line items and four of the six expense lines, we used the dollar figures (as opposed to their percentage of total revenue). [Percentages next to these items were calculated using revenue for this "best of" pro forma.] For revenue sources, we used dollars because we want to hit the best potential revenue number all in the same year (or future years). Revenue drives the business. For Sales and Marketing and Travel and Entertainment expense line items, we used percentages of revenue because they vary, at least to some degree, with revenue.

For cost of goods line items (Materials, Labor and Direct Overhead) we used percentage of revenue (instead of dollars). [The dollar figure has been calculated using the percentage and pro forma total revenue.] This is because these expense categories are variable. That is, they vary with revenue. As sales are made, expenses must be incurred to deliver the product or service.

Similarly, for four of the six expense line items (Payroll, Rent and Utilities, Office Supplies and Misc. Office and Professional) we plugged in the dollar amounts. This is because these expenses are fixed (i.e., they do not vary much with revenue).

Show Me the Money

If you've done it before, you should be able to do it again, right?

Based on our analysis, CFS has the very real potential to do $1,420,000 in revenue and put $223,110 on the bottom line - a full 15.7% operating profit margin. This compares to a five-year high-water mark of $66,000 in profit and 5.5% operating margin.

How can this be? Simply by managing each line item to hit the historical-best line-item performance. Nothing new required whatsoever.

Easy? Maybe not, but definitely doable.

Get Focused, Rally the Troops

The beauty of internal benchmarking is that it's low-cost, relatively easy and effective. It can be your beacon of light for continuous improvement.

Yes, a key question will be HOW to hit your new line-item targets. The first step is to do the analysis. Then investigate how you achieved the desirable performance in that line item that "best" year you identified. For that task, get your employees involved.

Next, get your spreadsheet - just like the one for CFS - printed in wide format. Place it on the wall. Assign a single person to each line item and make it his/her responsibility to hit the target. Tell them that they have 100 percent support from you and the rest of the team (and make it so). Provide bonus incentive for results.

Track performance by month and year-to-date, and watch the momentum build. You'll develop line-item fanatics. Revenue enhancement missionaries. Cost reduction hounds. The result will be a soaring bottom line.