16 Sep Using KPIs to Monitor and Improve Business Performance
Author: Tom Gillespie
In a previous article titled Better Financial Information, Better Decisions we discussed how maintaining up to date and accurate financial records can provide business owners and managers with better information from which to base their management decisions. In this article, we introduce the concept of Key Performance Indicators (KPIs) and how they can further improve decision making within the business.
Key Performance Indicators
A KPI is a measurable value that demonstrates how effectively an organization is achieving its business objectives. Organizations can use KPIs to evaluate their success at reaching various targets, to maintain performance at a desired level, or to seek out areas for improvement. High-level KPIs may focus on the overall performance of the business, while lower-level KPIs may focus on processes in departments such as sales, marketing, HR, support and others.
When developing KPIs, a business should ensure that they focus on what matters most to the business and that the KPIs provide actionable information. If the information is not that relevant to what the business is trying to achieve then the KPI will not be very effective. Further, if the KPI is not actionable, that is you don’t know what to do to improve it, then it is also not very effective.
Availability and Accuracy of KPIs
KPIs that are only available intermittently such as on an annual basis are not very helpful. If you only monitor them once a year you only get one shot at trying to determine what impacted your KPI. What you want to achieve is regular feedback that can provide you with insights on a more timely basis so that you can evaluate what helps and what might hinder performance. Furthermore, KPIs need to be based on accurate information. Information that is distorted from improper recordkeeping and timing differences between periods could lead to incorrect KPI values that do not reflect the performance of your business. Accurate information provided on a regular basis is the only way to effectively monitor the performance of a business.
Generic Business KPIs
Most businesses generally have a goal to improve cash flow and profitability. This means most generic KPIs used across many industries focus on these measures. The general approach to using these KPIS is to calculate them based on historic information and then set targets or goals to improve them. Once this is done, the business monitors the KPIs on a regular basis and make attempts to improve them. That way you can assess what processes or actions best improve the KPIs and direct more of the business’ resources to these tasks. Let’s look at three common and important KPIs.
Accounts Receivable Turnover
Accounts receivable turnover is the measure of how fast the business collects its debts from its customers. In general, the faster your collect client accounts the better your cash flows should be. Many small businesses struggle with debt collections and this KPI can help focus the business on improving this. There are many ways to improve your collections such as issuing account statements to clients, following up on outstanding amounts, accepting credit cards and online payments, or using an accounts receivable management application to assist in this process. As with any KPI, when monitoring this value, you want to measure what actions you can take to improve it and then evaluate the results. You should find that when the business takes the right actions the KPI will improve and then you can set your sights on improving it further. The key is to monitor the KPI, take action, monitor, take action, and so on. Focusing on accounts receivable turnover alone could help improve cash flow, reduce the need for debt financing and improve the profitability and overall financial health of the business.
Similar to accounts receivable turnover, the inventory turnover measures how fast the business converts inventory into revenue. The faster the turnover the better the cash flow for the business. There are many ways to improve inventory turnover such as accurately forecasting sales and maintaining as little inventory as needed to keep up with client demands. Businesses that truly understand their inventory turnover can implement just-in-time delivery so that when a customer makes an order the inventory is quickly shipped from the supplier to your warehouse or storefront and ultimately to the customer which means you have less cash tied up. Shipping directly from the supplier to the customer or discounting older inventory to incentives sales are other ways that this metric and be improved. If inventory is a big part of your business then you should monitor at least a few KPIs in this area.
Most businesses are familiar with the concept of gross margin, which is the profit from your sales less all of the direct and indirect costs to make the sales. However, we find that many small businesses only have information sufficient to calculate this KPI for the business as a whole and often times only for the year, after we have assisted with the year-end financial statements. Calculating gross margin once a year is not very timely. Gross margins work best as a KPI when they can be calculated regularly (quarterly, monthly, weekly, etc.) as you can act on the incoming information more regularly. In addition, gross margin for the whole business is not very actionable as you may not know where your time and resources will be best spent to improve profitability. Calculating gross margin on a departmental basis, by location, or by product item can be much more revealing. This way you can track which locations or products are not contributing as much profit as you expect and focus your time on improving these areas. This KPI analysis may even reveal to you that some product or service lines are not even profitable! In these cases, a business needs to take significant actions to make these profitable or may decide to drop these products or services altogether and focus resources on growing only the profitable areas. The important thing to take away here is that you need the right information to be able to make the right decisions.
Industry Specific KPIs
The above generic KPIs apply to most businesses but it is often the combination of generic and industry specific KPIs that can best provide insights to improve business performance. KPIs that work for a professional service company likely do not work as well for a manufacturing company and vice versa. You want to pick several KPIs that best provide insights into your business.
Designing industry specific, or even business specific, KPIs can be difficult. It requires a good knowledge of the way your business works, of accounting systems, accounting policies, and the way in which you collect and manage your data. As accountants and business advisors, we can help you improve the way in which your business collects and manages data as well as kelp you design KPIs that will provide you with better information on which to base your business decisions.
How Can Clearline Help?
Clearline helps their clients better collect and manage information. We can also assist in developing KPIs and in creating efficient ways to monitor KPIs and improve your company’s financial performance. If you are interested in talking about these topics please feel free to reach out to the partner or manager on your account at Clearline. You can contact us here.