Rankings Build Credibility

Rankings Build Credibility

By Dave Miles

Benchmarking provides empirical evidence, the hard numbers needed to determine the company’s industry standing, strong, weak, average, as a factor in making decisions about ongoing cash flow and risk. The range of value between a weak company and a strong company in a marketplace is considerable. If you can pinpoint performance through benchmarking data, you can better substantiate your conclusion of value. This builds credibility.

Most benchmarking sets of data provide averages for the common size statements and ratios. This means outliers are included which skews the data. The RMA Valuation edition is the only benchmarking data that provides the entire ranking from the 10th – 90th percentile for both elements on common size statements and ratios. Understanding the significance of the differences between the average, median and percentile ranking are what builds the credibility of an expert.

What is a Ranking?

A ranking is more like a median than an arithmetic average. It says how many items are below a ranking percentage and how many items are above. The median means 50% are above and below. If your ranking is the 65th percentile, then 65% of the sample is below and 35% is above.

Typically, the average value of a benchmarking data point is skewed compared to using the decile data (i.e., the percentiles 10-90). This is because outliers can raise or lower the average. For example, if an average charitable contribution is $100 and through ranking, you discover that median (50th percentile) contribution was $60 and that $100 is the 65th percentile, you know that there were contribution(s) significantly higher than the median that skewed the average significantly upwards. If you take this example and apply it to financial benchmarking, you can see that being able to “rank” an element of a company’s financial statements is more precise than comparing them to industry averages.

Rankings therefore increase credibility because the data is more meaningful. It means the difference between being able to say a company is ‘average,’ to being able to say the company is performing better than 65% of its peers.

Disadvantages of Ranking

The data must be valid. If you are breaking a sample into 10 pieces, there needs to be enough data to make a comparison. The example I would give is that if the sample population is only 10 companies, breaking it into 10 pieces does not mean much. A large sample is necessary.

Also, the rankings are by elements (think a single ratio) and not by the whole (a company ranking). Companies are not ranked against each other, but individual characteristics are. The ranking process will not allow the expert to say company A is in the 65th percentile, but that an individual element is. Every company will have strong ratios and characteristics, and weak ones. But ranking will provide a starting point with a different perspective than averages. It is the expert’s job to clearly say what those are, and ranking can help that process.

While not necessarily related to ranking alone, the interpretation of the element must be done with savvy and judgement. Say a current ratio is 8 or 9, very strong, the expert will have to figure if there is excess cash not being used to grow the business (strength) or if there is a lot of stale inventory (weakness). Every expert will have to put their expertise on the line to say how the company is performing.

More About RMA Data

Risk Management Association (RMA) data is based on actual company financial statements. This data is not modeled in any way and is updated yearly. The data is collected by banks that receive financial statements for loan applications, and these are provided to RMA. This means that for some industries and size categories, there are a limited number of companies represented, but it also means the data is very current (less than a year old) and reflects events such as COVID. The collection and aggregation processes are transparent and documented. RMA data is very well respected and has been around since 1916. Having a completely transparent collection and analysis process based on actual company financial data can be an advantage over modeled data. In addition to the data contained in the standard RMA Annual Statement Studies database, the Valuation Edition contains enhanced information, including national and regional data, the ranking in 10 deciles for every variable, an income statement and balance sheet presented in dollars ($) as well as in percentages (%), and industry growth rates. The enhanced data allows valuators to “rank” a company’s financial statements against RMA data, providing a much more precise picture of how the company is performing.

Click here for more information on RMA Valuation Edition.