At FinancialSoft we occasionally receive questions about why NAICS code information is not “regionalized” or segmented by company size…
The North American Industry Classification System (NAICS) is the standard used by Federal statistical agencies to classify business establishments for the purpose of collecting, analyzing, and publishing statistical data related to the U.S. business economy. The NAICS system replaces the Standard Industrial Classification (SIC) system. Companies that collect financial performance data use the NAICS codes to categorize groupings of company types. That is why FinancialSoft requires your NAICS code to run your financial report.
Though each company fits into a NACIS code classification, many companies feel they need to be compared to industry peers that are located in their same geographic region or market, as well as the same business size measured by annual sales. FinancialSoft reports measure financial metrics ratios, not absolute numbers. Ratios allow large companies to be compared to small as well as compare similar size companies across the country.
To better illustrate this we will use an example of Gross Margin, an Income Statement Ratio used in our financial reports. The Equation for Gross Margin is:
Where Gross Profit = Sales – COGS(COS)
Consider two companies with the same NACICS code; one small the other large. Let’s say the companies both sell home theater electronics. Looking at a single part such as a home theater receiver the small business purchases the receiver for $550 and the larger retailer for $500. If the large retailer sells the receiver for $1,000 this yields a gross margin of 50%. If the small company prices the same receiver at $1,000 they will only have a gross margin of 45%. But the small retailer has more personal service and can spend more time working with the customer to tailor make their system, something the larger retailer does not do. This additional service can allow the smaller retailer to increase the retail price to $1,100 resulting in the same Gross Margin of 50%. So size or annual sales get normalized by the ratio.
If we were to look at regional differences we would find the same normalization. In this case we will use a carpet cleaning business. One business is located in Manhattan Island New York and the other is in Des Moines Iowa. The company in New York charges $75 per room whereas the Des Moines company may charge only $50 per room. Even though the retail prices are very different, the Gross Margin ratio can still be similar. The Gross Profit is Sales minus COGS or COS. The labor and materials in New York are considerably higher as the cost of living is higher than Des Moines. Therefore the higher COGS will compensate for the higher Sales price, reducing the Gross Profit resulting in similar Gross Margin percentages.
The Industry data provided in FinancialSoft reports is there as a reference so your company can see where you stand against your industry peers. This valuable data can help guild you to finding opportunities that you may not have known without this data. We realize no company can fix all their financial issues at once, so this data will give you a benchmark that will help you focus on the most significant issues first.