Key Performance Indicators – Part 2 of 2

This is the second post in a two part series on Key Performance Indicators (KPIs) for small business.  Part one dealt with identifying the Critical Success Factors in your business and defining KPIs to monitor performance.  This post will discuss integrating a system of KPI reporting into your performance management practices.

Constructing A KPI

The critical thing is getting the description to a level of detail that makes it measurable in a way that gives a meaningful result.  A KPI itself isn’t about doing anything – like reducing defects for example. It’s the measure, not the desired outcome.  What is important is that you decide on a definite measure and, having decided, you stick with doing it that way – changing what you include in your KPI or the way you measure it will mean figures can’t be compared from one period to another or to your target, so they won’t be of any use to you.

If you haven’t thought out what the target should be, you probably won’t know when you have achieved an acceptable outcome. Sure, you might know a KPI is down this month vs. last month, but in the long run what do they need to get down to – to be acceptable?

KPIs Should Allow For Correction

It should point to the activities you might need to alter if things start to go off track. Since KPIs are the measures of those processes and financial markers that are critical to your business’ success, when they move in the right direction you know you’re on track towards achieving your objectives. When they move in the wrong direction you know you have an issue to address. So they really ought to point to just what is contributing to the problem so you can do something about changing things. You may decide you have a problem with cash flow, but is it due to slow paying customers, poor internal cash management processes, not enough sales, or a combination?

To determine this you’ll need to drill down just a bit further by using sub-system KPIs.

KPIs For Different Activities – Sub-System KPIs

You might remember in part one that we discussed a business should have only a few KPIs, maybe 6-8, to measure their CSFs and judge how they were performing in achieving their goals – that’s for tracking the business as a whole.

In reality, the business wide goal may be interpreted into different activities for different activities or processes. So while the company goal may be to improve cash flow, for the sales activity this may translate as improving income by increasing sales, while for accounts receivable it might mean reducing days in receivables – that revenue from increased sales is no use until you collect it! So now we have to introduce KPIs to measure how sales are going and how days in receivables is going. In fact we may set up 2 or 3 KPIs in each area and we refer to these as sub-system KPIs.

When it comes to using KPIs to target areas needing correction, it’s necessary to take this more granular approach and set up a number of KPIs that track what’s going on in individual areas in detail.

An example will give you some idea of how this works. Cash flow is a CSF for any business because if a business runs out of money it will cease to exist. Hence, the processes involved in tracking and maintaining cash flow require measurement through KPIs. This example will also illustrate how measuring sub-system KPIs can pinpoint areas you need to work on.

KPIs In Action: Cash Flow – Aligning Strategies

One of the most common KPIs for cash flow is days in receivables – the average number of days it takes for you to get paid. Too long, and you can experience critical cash flow bottlenecks.

So you’ve put in place a way of measuring days in receivables and find it is sufficiently outside the industry average to be worrying. Tightening up could improve the situation quite a lot.

You look for remedies – and there are many. Among them, going for an aggressive collection policy – you know, calling up your debtor the first day after the due by date, sending in the debt collectors a week later. That sort of stuff. Great, you’re getting your money in record time – that’s right – customers might end up feeling harassed and take their business elsewhere.

So what went wrong? There’s been a failure to look at the bigger picture. Looking at both sides of the equation allows us to come up with a happy medium and ensure that your team understands that you are not prepared to have days in receivables decrease at the expense of customers, that is, at the expense of another CSF, that of maintaining or increasing customer numbers.

Lesson 1 with KPIs – when considering remedies assess the likely impact of your strategy on the business overall. The action you choose must not push the achievement of one CSF at the expense of another or the achievement of one goal at the expense of another.

KPIs In Action: Cash Flow – Pinpointing Actions

You’ll recall we discussed that a business’ overall goal could translate into a set of goals for different activities. With cash flow, for sales activities this might be simply to ‘increase sales by 2% each quarter’, or whatever. Achieving this will help the business achieve better cash flow.
The KPI for this will be gross sales value.

So, we’re monitoring gross sales and we note that it’s not improving. What do we do? Well, you can’t pinpoint exactly where you need to focus your corrective action if you are unsure of why gross sales have dipped. And you can actually determine that by having set up some KPIs to measure the activities around sales itself. By looking at these sub-system KPIs of sales we have a better opportunity to identify the
real issue.

Generally, sales are made by obtaining sales leads, and converting those to actual sales. If we look at the sub-system KPIs of the leads generated and the leads converted, we can quickly see what area isn’t performing. We are then able to take action based on whether we need to address our advertising and marketing to generate leads, or whether or not it is our
sales process and methods that need work.

We can then also decide if we require additional information and what type of additional information is required in order to make an even more informed decision. Say, for example, that conversion rates were dropping, we may then need to dig further into differences in sales
people’s conversion rates or even look at seasonal comparisons.

If we are routinely keeping this type of information we are able to notice trends and react much faster to changed circumstances.

Managing KPI Information

Let’s turn to what’s actually involved in collecting and managing data for a KPI monitoring system. There are several things to keep in mind here:

• The information should be easy to gather
• You need to gather it on a regular basis
• The information you gather needs to get to the right person, that is, the one responsible for the process it measures
• The information should be promoted among team members
• Remedial actions need to be coordinated across the operating units

Let’s look at each:

KPI Data Should Be Easy To Gather

In the design stage you must establish that the process is measurable and that the benefit the information will provide outweighs the cost of obtaining and maintaining the data.

The person who controls the process generally understands the most efficient and effective way to measure that process. They will have a much better idea in terms of obtaining useful data to demonstrate where issues arise, and motivating the team to achieve the desired results.

If the data can be collected and or analyzed electronically to save the time of doing it manually so much, the better.

Gather KPI Data On A Sytematic Basis

For KPIs to be useful in the management process they need to be compiled and reviewed on a regular basis. How regularly individual KPIs are monitored is dependent on the KPI itself and the process it is measuring. The general rule is that the further down the process level of the organization, the more focused on specific functional activity, the greater the frequency of the
reporting.

The frequency of reporting becomes more evident once a KPI is defined. There is absolutely no point having a KPI reported on daily, when nobody looks at it for 30 days or if there is nothing that can be done to adjust the process anyway.

Still, at the manager level a lot of numbers ought to be checked regularly – sales for the previous day, the backlog of orders or deliveries, how much inventory is available and so on. All can provide early warning of developing problems and allow them to be dealt with.

KPI Data To The Right Person – Quick!

KPIs need to be available to the right person or people in the organization.  They shouldn’t sit on the boss’ desktop if they need to be seen by the people in charge of the operation they report on.

And they shouldn’t go for action to team members who have no control over the activity that is being measured. Ensure the person who is expected to operate on the information has been involved in the setting up of the project so you can count on their buy-in, and that they have the authority  to make things happen.

Promote KPI Data Within The Team

It can be very useful in promoting company policy and getting buy-in to make sure team members see some of the data that is being gathered – particularly in their area of operations. This can be done as a scoreboard, that is, a chart or handout, to the team. It can show the numbers that drive business profitability – sales, COGS, etc. and the KPIs for the critical success functions in their area. Some companies even include the team’s bonus evaluation forecast based on the to-date KPI indicators for profit! It can be a pretty good motivator.

Providing the scores and explaining the situation is one way of keeping them focused on the jobs that really need doing and encouraging them to move the KPIs in the right direction.

Of course you may need to do some training around this – how many of your team would know what ‘operating efficiency’, ‘turnover’ or ‘gross margin’ mean if you presented these figures to them cold? But once they do understand what they mean, and have them available, you can also use them to brainstorm ideas on improving the situation.

We’ve already discussed this in the cash flow study so here’s a couple of examples just as a reminder.

Actions to achieve KPI targets may actually conflict with each other in terms of achieving the overall plan. For example, the goal to minimize inventory stocks may jeopardize another goal such as improving customer order fill rate. You still set up the KPIs, but you need to consider the strategies for achieving the individual goals so the overall plan isn’t damaged.

Another example: If the goal was to build gross sales, the sales team might achieve it through massive discounting. So if one of your KPIs here was ‘number of sales per salesperson’ it might look pretty good. But obviously it’s not a viable strategy and you’d need to have either ruled out discounting as a strategy from the beginning, or maintain KPIs on net margins, gross margins and cost per sale, to ensure it didn’t get out of hand.

The way you choose to improve a critical number has to be consistent with the overall business plan.

KPIs And Business Performance Management

Well, that’s pretty well it for how to create KPIs, but as we had mentioned in the beginning, we gather KPIs for a reason – and that reason is to improve business performance. And the basis of improving is monitoring.

There are 3 main ways of monitoring performance:

1. Have a business plan to guide your activities.
2. Carry out regular financial analyses of operations.
3. Benchmark your activities against other businesses or the industry to see how you stand.

Each of these will provide you with the essential underpinnings of a useful KPI system – goals you want to achieve. Knowing the goal allows you to identify CSFs; and knowing your CSFs points to the KPIs you’ll need to track.

KPIs, Your Business Plan And Financial Reports

Having a documented business plan provides the opportunity to set out just what you want your business to achieve and how you’ll go about getting there. In doing this exercise you gain a very realistic appreciation of your market, your competitive positioning and your capabilities. But a good marketing plan will also develop some realistic goals to aim for and these become the targets for the KPIs you measure. So you know that the KPIs you are monitoring are the right ones for showing if the business is going in the direction the plan has set out.

We also recommend that you have a set of key financial ratios prepared on a regular basis as well – not just your profit and loss account and balance sheet but also a detailed monthly cash flow analysis for instance. Your financials form a major set of KPIs for your business.

Remember that KPIs relate only to your own firm – they measure how your operations are
working out; so many sales per salesperson, so many days in receivables etc.  But, apart from the fact that these might show you are moving in the right direction, what do they say about how you stand with regard to what other firms are achieving?

If you take the KPI figures from a number of similar firms and use them to construct a chart showing the average figure for poor performing firms, the industry average overall, and how the best performers rate, then you have a benchmark against which you can compare your own performance.  The best way to make sure KPI monitoring happens is to set up a system for regular reporting of results – most accounting software packages allow for this.

Some people refer to KPIs as their ‘critical numbers’ and that’s no exaggeration of their importance.

When you consider that a well designed and regularly monitored set of KPIs can provide you not just with a knowledge of how your business is performing, but also target the areas where remedial action ought to be applied, then you can understand why they take them so seriously.

We hope this blog will encourage you to think about the value of goal setting and using KPIs to monitor progress – they really are the basis of effective business performance management.