Small business benchmarks methodology and ratio calculations
Small business benchmarks are key financial ratios drawn from information provided by businesses through activity statements and tax returns.
Businesses and their agents use benchmarks to compare business performance against similar businesses.
Benchmarks are updated with new financial-year data on an annual basis. The update ensures benchmarks reflect the performance of businesses over time.
The methodology used to develop the Small business benchmarks has been assured by an independent third party.
To view the report, refer to:
For more information about our benchmarking program, including how to compare your clients' business performance against the benchmarks, refer to:
Our benchmarking methodology consists of 10 main steps to produce a performance benchmark.
Step 1 – Identify industries to benchmark
This step determines the industries we will benchmark.
Small business benchmarks are currently limited to businesses that supply goods and services directly to consumers where cash is often used for payment.
Generally, businesses in these industries demonstrate a higher likelihood of deliberately using the cash transactions to hide income and evade taxation obligations. The essential characteristic is that transactions go unrecorded and unreported.
Identification of an industry type to benchmark is based on a multiple of factors, including the size of the industry population.
Industries identified for benchmarking are initially categorised according to their ATO Business industry codes.
Business industry codes are a unique 5 digit identifier adapted from the Australian Bureau of Statistics and Statistics New Zealand, 4 digit ANZSIC code. The 5 digit business industry codes expand on the 4 digit ANZSIC to refine the industry classifications.
Businesses are not allocated to a benchmark industry based solely on the ATO Business industry codes. A keyword process is used to further refine the data based on information reported at the main business activity and trading name labels on the income tax returns and business registration. The keyword process is explained at step 3.
Step 2. Identify the starting population of the industry business types
This step determines the starting population that are in business.
The starting population for a benchmarked industry is currently identified 12 months after the income tax return statutory due date of lodgment. This allows for a reasonable amount of time for most of the income tax return and activity statement lodgements to occur, including those businesses with extended lodgment periods.
For example – the starting population for the 2009-10 financial year was identified only after 31 October 2011 had passed.
Firstly, the starting population of a benchmarked industry is selected based on businesses that:
- lodged their income tax return for the year to be benchmarked
- are registered and have an active ABN
- report the selected ATO Business industry code on their income tax returns or business registrations.
Secondly, businesses are excluded from the starting population if they:
- are currently insolvent
- are deceased
- are in the not-for-profit, government or large market segments
- are not companies, partnerships, trusts or individuals
- have a tax file number (TFN) identified as compromised
Thirdly, further data is captured and filters applied to:
- exclude businesses with turnovers of less than $30,000 and more than $15,000,000
- exclude businesses that have reported multiple business activities on their income tax returns
- exclude those that have been in business for less than 1 year before the start of the financial year being benchmarked
- capture the latest returns lodged for the benchmark year, including amendments
- limit the population to those that have lodged returns within one year from the statutory due date of lodgment.
Step 3. Industry allocation – grouping businesses into industries
This step allocates business to specific industries.
Businesses are grouped into industry sub-groups based on having a common business model.
Groupings into industry sub-groups are based on keywords identified from the information businesses report at the main business activity and trading name labels on their income tax returns and business registrations.
The keywords are used to identify a business as either suitable or unsuitable, and therefore not included, for allocation to a benchmark industry sub-group.
This process will include instances where the ATO Business industry codes may include more than one industry sub-group.
For example – we have published three benchmark industry sub-groups from ATO Business industry code 32430:
- Carpet laying services
- Tiling services – floor and wall
- Timber floor sanding
A benchmark industry can also consist of multiple ATO Business industry codes where similar sub-groups report within multiple codes, recognising that businesses often have diverse product lines but similar financial performance.
For example – the Meat and poultry retailing - fresh benchmark industry consists of:
- Meat retailing – business industry code 41211
- Fresh poultry retailing - business industry code 41213
Industry allocation keyword process
The keyword process allocates a business to an industry sub-group based on a three step key word process:
1: Income tax return
Assign the relevant industry sub-group population by identifying businesses that have reported either of the following on their income tax return:
- the relevant ATO Business industry code and keyword description at the trading name label
- keyword description at the main business description label.
Step one can also use keywords to exclude businesses that have reported certain descriptions at the trading name label on the income tax return.
2: Business registration
Assign the relevant industry sub-group population by identifying businesses that have reported all the following:
- the relevant ATO business industry code, in their GST business registration
- keyword description at the trading name label on the income tax return
- keyword description at the main business description label on the GST business registration.
Step two can also use keywords to exclude businesses that have reported certain description at the trading name label on the income tax return.
Use keywords regardless of the ATO Business industry code, reported on the income tax return or GST business registration. However it is limited to only identify keywords from the pool of ATO business industry codes selected for benchmarking and not from the total business population.
Step three doesn’t apply to all of the benchmark industry sub-groups. It can consist of up to four parts:
- allocate the businesses to an industry sub-group only when the trading name label from the tax return and the main business description label from the tax return both contain one of the key words
- allocate the business to an industry sub-group only when the trading name label from the tax return and the main business description label from the GST business registration both contain one of the key words
- allocate the business to an industry sub-group only when the main business description label from the tax return and the main business description label from the GST business registration both contain one of the key words
- keywords excluding a particular business from an industry sub-group can apply to the trading name or the main business descriptions.
The keyword process identifies businesses that may have incorrectly reported their ATO business industry codes and allocates them into an industry sub-group.
Step 4. Calculating benchmark ratios
This step calculates the benchmark ratios using specific labels on the income tax returns and activity statements.
Refer to ‘How benchmark ratios are calculated’ section for further information.
Step 5: Calculate the outliers
This step removes statistical outliers to ensure the benchmarks are based on data representative of the population.
Outliers are taxpayers whose reported data is significantly different from the majority of the other observations in the population. These outliers may have a significant influence of the rest of the sample. They are removed because they may be extreme cases, mistakes or not part of the industry population intended to be benchmarked, for example they have misclassified themselves but not changed their name.
Outliers are identified using Mahalanobis Distances, a statistical measure that examines each ratio in relation to the sample mean and the distribution of all of the other ratios. Those with a high Mahalanobis Distance measure are considered to have a significant influence on the rest of the sample and are excluded as an outlier.
Step 6: Assign turnover ranges to benchmark industries
This step assigns the turnover ranges to the industry.
Benchmark industry populations are segmented into turnover groups to account for the variations in business performance that may occur due to the size, location and turnover of a business.
The turnover ranges are different for each of the benchmarked industries.
Three turnover ranges are used for most of the benchmarked industries, to present the information in a simple format. Benchmarked industries with smaller populations may be presented with only two turnover ranges.
Generally, the ranges represent low, medium and high turnover ranges.
Turnover ranges are determined by analysing the distribution of results for each benchmark industry. Industry specific factors, including any clusters and trends in reporting, are included in this analysis. The appearance of any of the clusters or trends may help to determine the turnover ranges, as the selection of the turnover ranges may be influenced by any variability in the distributions of results and by the gradual increase in the average of the key benchmark ratios.
Step 7: Calculation of the benchmark ranges
This step assigns the ratio ranges around the average (mean), for example the ratio of total expenses to turnover for each turnover range.
For every industry benchmarked we calculate the average ratio for each turnover range. However we recognise that business model, location and region affect business performance so we determine a range around the average.
The range is represented by 30% of population around the average.
For example, a benchmarked industry with a regional area ratio of 37% and a metro area ratio of 35% would be captured within the benchmark range of 32% to 40%.
All benchmark ratios are published as whole numbers. Conventional rounding rules apply.
Step 8: Statistical assurance
This step ensures the populations are statistically valid and allows us to determine whether the ratio is a valid indicator of omitted income.
Normality and homogeneous testing
The statistical validity of the benchmarks is tested by checking that the benchmark populations are normally distributed and homogenous.
The selection of the key benchmark ratios and the secondary benchmark ratios for publication is dependent on the outcome of the normality and homogeneous testing.
Benchmark ratios are only published if they satisfy the normality and homogenous testing.
Key benchmark ratios
The key benchmark ratio is the benchmark we use to identify businesses that may not be reporting some or all of their income. We may also use this ratio to determine income that we have identified as not reported.
We identify these to make it clear to businesses and tax practitioners what benchmark we consider to be the most accurate predictor of business turnover.
For a benchmark ratio to be selected as a key benchmark ratio, the benchmark industry population must satisfy the following requirements:
- be normally distributed and homogenous
- the proportion of the population reporting the benchmark expense will be 50% or more of population within the turnover range
- the population count within the turnover range will be greater than 50.
If more than two income tax return benchmark ratios satisfy the key benchmark ratio test, then we take into account the percentage of the population reporting the expense to select the most accurate predictor of turnover for an industry.
For example, cost of sales is considered an accurate determinant of sales for retailers because it is a variable cost that generally changes in direct proportion to the increase or decrease in sales.
The activity statement benchmarks are only published as a key benchmark ratio. They are not published if they do not satisfy the key benchmark test.
Secondary benchmark ratios
Secondary ratios are those not identified as a key benchmark ratio. For a benchmark ratio to be selected as a secondary benchmark ratio, the benchmark industry population will satisfy the following requirements:
- be normally distributed and homogenous
- the proportion of the population reporting the benchmark expense will be 25% or more of population within the turnover range.
Not all benchmark ratios apply to every industry, as some of the ratios do not satisfy the normality and homogeneous testing or the population analysis. For example, many services entities are unlikely to have significant cost of sales.
Step 9: Quality assurance testing
This step assures us of the quality of the process and output.
A quality assurance process is conducted on the benchmark process and the final output.
All of the benchmark ratios are reviewed prior to publication. This review is conducted to ensure there have not been any calculation errors of the ratios and that the results are consistent with our expectation of the relevant industry.
Comparisons with previous year benchmarks are undertaken to ensure consistency on a year to year basis. This comparison identifies if there has been any significant movements in the benchmark ratios from one year to the next.
However there is an expectation that there would not be significant variations on a yearly basis as the nature of the industries is unlikely to change in a short period.
Further analysis may be required if significant changes are identified to confirm if there are any factors that may be influencing this movement. For example – a decrease in the average of a key benchmark may be an indicator of a change in the reporting of the industry population.
We may compare the Small business benchmarks to external information and other published industry benchmarks when developing a new industry benchmark. This is done to gain an understanding of how the benchmarks compare.
Step 10: Industry names and overviews
This step gives a common sense name and descriptor for the benchmarks.
Benchmarks are published by industry name and include an overview of the industry characteristics.
The main focus of the industry overview is to describe the industry being benchmarked. The industry overview is based on the population captured within the benchmark industry.