The business landscape is changing, and the finance group is required to cut costs, grow revenue, and maintain control in an increasingly uncertain environment. Traditionally we have relied on reports, an inefficient process that takes time to prepare and then informs you of past progress, not what is happening at this moment.
Compare that with driving a car: you have an objective to reach a certain place at a certain time, and you have a forward view through the screen, a rear view mirror and a dashboard. The satnav telling you your estimated time of arrival is a key indicator of how you doing and you can ignore the odometer saying how many miles the car has already travelled – but that would become a key indicator if you were scheduling a service.
If you see a traffic camera ahead, suddenly the speedometer becomes the key indicator. If you see a sign saying “last fuel for 100 miles”, then the fuel gauge is suddenly key – while a flashing blue light in the rear view mirror changes all your priorities.
Such KPIs – Key Performance Indicators – are vital to help businesses, and especially CFOs, optimise performance. They provide insight into the here and now, and how it is directing what is to come – unlike a report on how you did in the past. As the example shows, these KPIs have a dynamic relationship – information from one set of performance indicators can suddenly draw attention to the key role of another indicator – so we need to access them in real time, not in a historical report.
According to investopedia.com: a KPI is: “A set of quantifiable measures that a company or industry uses to gauge or compare performance in terms of meeting their strategic and operational goals”. The problem is that most CFOs still don’t measure KPIs, or are not sure whether they are looking at the right KPIs. Such uncertainty has a negative impact on business decisions.
What makes a performance indicator become a KPI?
How do you decide which performance indicators are truly key? Here are three principles to consider:
• A KPI must relate to business strategy. As a rule of thumb, limit your strategic goals to about 5 or 6 really important ones to allow a clear understanding without too many options. Then the data should correlate with that strategy. If your business strategy includes increasing the company’s value, then you may tie “revenue growth” into a KPI.
• KPIs must be measurable. A KPI must give a clear measure of business performance. Qualitative measures are too subjective. So ask this: could everyone in the organization read this KPI and see the same results without any interpretive error?
• KPIs must be actionable. A good KPI will have a clear threshold or target: anyone who looks at it should see whether the company is below, on target, or above the goal. If the performance indicator is truly key, a poor result will trigger remedial action.
One you know what to look for in a KPI, you can then start determining which KPIs to monitor. Here are six guidelines:
• Keep it simple. Tying KPIs directly to your business strategy means that a few solid, focused strategic goals will encourage a few solid, focused KPIs. The actual number will vary according to your business, but four to ten KPIs is a good range.
• Be unique. Do not make the mistake of Googling “commonly used KPIs” and using them all. KPIs must be based on your actual business’ strategy and realistic performance. If you start with “commonly used KPIs”, only choose the relevant ones.
• Don’t settle. If your KPI doesn’t meet the above three criteria (tied to business strategy, measurable, and actionable), keep looking. There must not be any confusion about what the KPI is, where the data comes from, and what is a good or bad result.
• Focus on business units. Generally, you should monitor separately business units with disparate functions, like retail versus services.
• Avoid limitations. If there have to be assumptions or limitations in the KPI data, make sure this is explained alongside the KPI.
• Integrate. KPIs bring data together from all parts of your business. You may need to integrate information from critical business systems, like ERP and CRM, and even custom systems too.
So what’s wrong with reports?
Reports play an important role. You need them to protect vital assets, ensure compliance, and close the books accurately. They help you run the business smoothly, while KPIs help the transition from running smoothly, to running fast. Reports look backwards to what happened yesterday, or last month. They lack insights to help drive strategy forward.
However, reports don’t show your goals, or how you are currently performing. They don’t provide insights or foresights to help a business decision or deliver pertinent, actionable information to other departments. When it comes to measuring performance, you need to move beyond reporting and adopt a KPI strategy to make decisions, and understand what’s going on, faster and with greater clarity.
Shifting gear to KPIs
To truly identify KPIs you should interview users – people who ask for reports – to determine what they are truly looking for. The challenge is to get them to articulate their real needs. These five questions will be a guide:
1. What is the first thing you look at? Sit down with users and a copy of a common report and ask them circle the most important piece of information. Nine times out of ten, they go to the bottom and highlight a grand total. Ask this question several times – there are often multiple performance indicators on a single report.
2. Why do you look at that? Having received a list of key data, ask what are the business drivers that make this data key? Expect a response like: “If this number is high, it means…” or “If this number is low, I need to…” There should always be a business reason.
3. How do you know if that result was good or bad? This person has sense that the data is good or bad: your job is to quantify that for other users. If being good means comparing well with other information not in this report, you know that the useful KPI must combine information from multiple sources.
4. What will you do if it is bad (or good)? Look out for things that are actionable. If a bad result means going to the department head to suggest changing the processes, this could be a KPI.
5. When do you monitor this? If the KPI is difficult to calculate, or requires a lot of information from different places, it may not be monitored as often as a more straightforward KPI. For example: if you could monitor revenue every day, instead of every month, you could put a process in place or try to change the behaviour to adjust the current trajectory.
As the role of finance evolves, you need to re-assess outdated, inefficient processes like reporting. According to Bernard Marr of the Advance Performance Institute, “Key performance indicators (KPIs) should be the vital navigation instruments used by managers to understand whether their business is on a successful voyage, or whether it is veering off the prosperous path”.
Every company holds valuable resources and experienced managers know deep down the measures they need and what a good and a bad result looks like. The trick is finding a way to get that experience out of their gut-instincts, into consciousness, and into a well-crafted KPI strategy.
(About the author: Paul Yarwood is CEO for Hubble, a brand of Insights Software)