Identifying & Leveraging your Key Performance Indicators

In an article on About.com, F. John Reh defines Key Performance Indicators (KPI) as “financial and non-financial metrics used to help an organization define and measure progress toward organizational goals. KPIs can … assess the present state of the business and assist in prescribing a course of action.”

Informationbuilders.com describes KPIs as “high-level snapshots of a business or organization based on specific predefined measures. KPIs typically consist of any combination of reports, spreadsheets, or charts.”

KPIs are quantifiable measurements that reflect the critical success factors of an organization. They will differ depending on the nature of the business and what its priorities are. Some KPIs should focus on short-term priorities and others on long-term strategic issues. So a typical business would have both sales for the current month and for the year-to-date period in its KPIs.

The Key Performance Indicators selected must reflect the organization’s goals. They must be key to its success, and they must be measurable. The definition of what they are and how they are measured do not change often. The goals for a particular KPI may change as the organization’s goals change, or as it gets closer to achieving a goal.

If a Key Performance Indicator is going to be of any value, there must be a way to accurately define and measure it. As a result many businesses start with financial indicators that are based on the accounting records. Financial KPIs can include metrics based on both balance sheet accounts and earnings accounts. For example, a bank balance or days sales outstanding are very common indicators based on balance sheet accounts. On the other hand, where statistical data is maintained they are as appropriate to be a KPI e.g. volume of product manufactured, number of orders received, headcount, etc.

It is also important to define the KPI and stay with the same definition from year to year. For a KPI of “Increase Sales”, you need to address considerations like whether to measure by units sold or by dollar value of sales. Will returns be deducted from sales in the month of the sale or the month of the return? Will sales be recorded for the KPI at list price or at the actual sales price?

F. John Reh says, “In selecting Key Performance Indicators, it is critical to limit them to those factors that are essential to the organization reaching its goals. It is also important to keep the number of Key Performance Indicators small just to keep everyone’s attention focused on achieving the same KPIs.” He goes on to say that it is often appropriate to have supporting KPIs that support the ones at the organizational level so, for example there could be a KPI for total sales and supporting KPIs for sales in specific markets.

Have a list of key performance indicators (KPI) and a set frequency of how often each one is updated (daily, weekly or monthly). It is relatively easy to reflect on the key issues that fluctuate in most businesses. Think about the factors that can be measured in the following categories:

• Customer Service
• Distribution
• Economic environment
• Environmental
• Facility maintenance
• Financial
• Governance
• Health & Safety
• Human resources
• Innovative
• Manufacturing
• Marketing
• Productivity (not just manufacturing)
• Quality
• Sales
• Supply Chain
• Technology – whatever technologies are relevant to your business

Examples of KPIs:

• Sales growth
• Gross margin, by category
• Production volume
• Cost accounting variances
• Number/percentage of new customers in the year
• Graduation rates of students
• Percentage of customer calls answered in the first minute
• Average call length
• Number of clients assisted during the year
• Average days sales outstanding
• Cash on hand/line of credit balance
• Inventory on hand

Update the KPIs regularly and incorporate them into the ongoing reporting and management of the business. Include them in the budgeting process and report the KPI compared to budget and compared to prior periods.

Ensure that you investigate and take action on any KPI that changes from expectation. Challenge your management to improve on selected KPIs each month. For example, make February the month in which you challenge your management to improve days sales outstanding by 10% (and then illustrate the success by showing the affect on cash flow).

Many businesses develop a “dashboard” to monitor the status of the identified KPIs for the business and there are software tools that facilitate this. For most businesses this is a standard way for all those with access to the dashboard to see the status of the KPIs (Confidentiality usually limits the staff with access to some or all the indicators). Where the accounting system is an ERP system that is maintained in “real time,” it may be reasonable to maintain instant measures of the critical metrics that drive your business. A feature that may be available with sophisticated systems may include an ability to “drill down” to see various levels of data that underlie the visible data and also the detailed data from which the metric is compiled. For example, a sales amount may show the sales in the current month and if one drills down one could ascertain the sales by product line. If you drill down even further you would get sales by product and eventually the individual invoices.

Without fast, automated access to KPIs, your employees often have to run multiple reports, or do detailed analysis to generate the same information. With a format and content to report the KPIs to management, the data is compiled in an agreed standard format and content and so all managers are looking at the same data and have access to it at the same time. It not only enables management to get faster access to the critical data but also to ensure that everyone with a need to know is informed and has the same understanding of the facts which are necessary for a decision or a course of action.

If you do not yet have a defined and agreed set of KPIs in your business this is an area that your Controller (whatever their title) should be able to develop, with input from management. It is not necessary to invest a significant amount in the reporting and if your ERP system does not have a dashboard module, it can and often is done in Excel. If you have a weekly snapshot, this is a form of reporting of the critical data for the business and an alternative to the reporting of KPIs.

James Phillipson is a Chartered Accountant and a Principal of Mastermind Solutions Inc. with over twenty years experience in large and small businesses. He has provided financial counseling to his clients since 1996, often in the role of a Controller or Chief Financial Officer, for both public and private corporate clients. James has experience in financial roles in a wide variety of businesses and industries. This includes several large corporations and many medium-sized public and private companies.

Click here for more finance information

View James Phillipson’s Profile