Like car owners monitor gauges on their vehicles’ dashboards, business owners should evaluate performance gauges known as key performance indicators (KPIs). These indicators can give them a heads-up about financial problems lurking down the road and help them make timely corrective actions.
KPIs differ from one company to the next based on the industry, type of business — business-to-business or business-to-consumer, for example — and, most important, the company’s objectives. Your KPIs will stem mainly from your business’s goals and mission statement.
Financial vs. nonfinancial gauges
There are two broad categories of KPIs: financial and nonfinancial. Financial metrics evaluate profitability, growth, cash flow, debt utilization, asset management and the like. Examples of financial KPIs are:
- Debt-to-equity ratio (total debt / shareholder’s equity),
- Debt-to-tangible net worth ratio [(total liabilities – debt) / (net worth – intangible assets + debt)],
- Current ratio (current assets / current liabilities),
- Days sales outstanding (number of days × accounts receivable / credit sales),
- Inventory turnover ratio (cost of goods sold / average inventory), and
- Average days to sell (365 / inventory turnover ratio).
Nonfinancial KPIs may include measurable business metrics in customer service, sales, marketing and manufacturing. Here are some examples:
- If a company’s goal is to improve its response time to customer complaints, its KPI might be to provide an initial response to complaints within 24 hours and to eventually resolve at least 80% of complaints to the customer’s satisfaction.
- If a company wants to improve its closing rate on sales leads, its KPI could be to convert 50% of all qualified leads into customers over the next six months and 60% over the following six months.
Notice that each of these KPIs is both specific and measurable. Just saying that your company wants to “provide better customer service,” “close more sales” or “reduce waste” isn’t quantifiable, so it won’t work as a sound KPI.
Reference points
Some basis of comparison for your KPIs is also important. A 50% close ratio or 1% unit reject rate might seem acceptable, but you need to compare KPIs to something. Benchmarks provide a standard against which you can compare your KPIs to see how they stack up against previous periods or the averages of other companies in your industry. Doing so will enable you to view your KPIs from the proper perspective.
Bear in mind that some formulas have slightly different versions. It’s important to know which formula is being used when comparing your results to those of other companies.
Start by benchmarking your KPIs from one period (for example, a quarter or year) to another. This will help you spot trends pointing to future problems so you can deal with them before they spiral out of control. For instance, an increase in your days in outstanding accounts receivable may indicates that your collections are lagging and a cash flow crunch is looming.
Risk Management Association’s Annual Statement Studies® can be a helpful starting point for industry financial benchmarks. This publication contains industry averages for financial ratios and metrics for hundreds of different industries. Your CPA can also provide more detailed or industry-specific benchmarks to use.
Employee participation
To achieve employee buy-in, consider establishing performance incentive programs that are based on achieving KPI improvement goals. Again, it’s critical to make your KPIs specific and measurable, and to share KPI reports with your staff to provide them with updates about how well the company is doing.
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