• Benchmarking
  • CFO.com | US

Is Finance-Cost Benchmarking Off Track?

Comparisons should take into account company complexity, not just industry and revenue, one research firm contends.

The typical method of establishing a peer group for purposes of benchmarking the finance function’s costs is lacking an important ingredient, according to research and advisory firm CEB.

When benchmarking finance costs, companies generally compare themselves to others in their industry (or related ones) that have fairly similar revenue. Many benchmarking tools also take that approach. But the most important comparison point is actually companies’ relative complexity, CEB contends.

The firm came to that conclusion during the course of its extensive qualitative and quantitative research into best practices for finance-department transformations, which often include efforts aimed at paring finance costs.

CEB quantifies a company’s degree of complexity through use of a proprietary index that incorporates many variables, says Tim Raiswell, a managing director of the firm. He declined to identify all of the variables but gave a few examples: geographic footprint; number of languages spoken where the company has operations; number of currencies supported; degree of IT integration and centralization; and number of legal entities.

Heavily weighting complexity in constructing a peer group “gets you much closer to a benchmark company that looks and feels like yours from a finance work-flow perspective,” Raiswell says.

Using industry and revenue alone as the basis of finance-cost benchmarking is “fraught with problems,” he says. “They’re useful in that they help you triangulate, but you need that third piece.”

It’s often the case that one company is more complex than another one that has significantly higher revenue. For example, Company Alpha is a manufacturer with yearly revenue of $8 billion. Company Beta is also a manufacturing company but with revenue of $15 billion. Conventional thinking would hold that the companies would have similar finance costs as a percentage of revenue (actually there would be an assumption that Beta would have slightly lower costs, given economies of scale).

But Alpha operates in more than 30 countries in which six different languages are spoken, while Beta operates only in the United States and Canada. In reality, Alpha’s finance costs as a percentage of revenue are not slightly higher than Beta’s, but rather far higher. They should not be seen as peers. “It’s comparing an apple to an orange,” Raiswell says.

One thought on “Is Finance-Cost Benchmarking Off Track?

  1. Benchmarks are often used and abused because size is often only one part of the performance picture. Risk and liquidity should also become part of performance measures.

    Manufacturing companies learned long ago that “too many parts” increased cost and operational risk (i.e. the probability that a broken part would make the entire unit fail costing it significant harm ). In the finance world the reaction to date to risk is to throw in another reconciliation task or even to hedge your hedges (see JP Morgan).

    As the CEB correctly points out a proper benchmark must consider complexity. I would also add benchmarks based on counterparty perspectives (i.e. a company that takes more risk than its counter-parties permit will fail. Ask your banks).

    These counter-parties can be internal too. Example: too much inter-company activity or too many inter company entities (e.g. borrowing) can signal a future liquidity or FX issue

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