The business landscape is changing, and companies are required to cut costs, grow revenue, and maintain control in an increasingly uncertain environment. Traditionally, businesses have relied on reports, an inefficient process that takes time to prepare and then informs them 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 rearview mirror and a dashboard. The sat-nav telling you your estimated time of arrival is a key indicator of how you are doing, and you can ignore the odometer saying how many miles the car has already traveled -- 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 rearview mirror changes all your priorities.
Such key performance indicators are vital to help businesses optimize performance. They provide insight into the here and now, and how it is directing what is to come -- unlike a report on how a business did in the past. As with the gauges and lights in a car, 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.
The problem is that most businesses still don't measure KPIs, or are not sure whether they are looking at the right KPIs. Such uncertainty has a negative impact on decisions.
WHAT MAKES A KPI?
How does a company 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, the strategic goals should be limited to about five or six really important ones to allow a clear understanding without too many options. Then the data should correlate with that strategy. If the strategy includes increasing the company's value, then they 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.
Once the business knows what to look for in a KPI, they can then start determining which KPIs they should monitor. Here are six guidelines:
- Keep it simple. Tying KPIs directly to a company's business strategy means that a few solid, focused strategic goals will encourage a few solid, focused KPIs. The actual number will vary according to the business, but four to 10 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 the individual actual business' strategy and realistic performance.
- Don't settle. If a 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, a company should separately monitor 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 a business. The organization 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. They're needed to protect vital assets, ensure compliance, and close the books accurately. They help run a business smoothly, while KPIs help the transition from running smoothly to running fast. Reports look backward to what happened yesterday, or last month. They lack insights to help drive strategy forward.
However, reports don't show a business' goals, or how it is performing now. They don't provide insights or foresights to help a decision or deliver pertinent, actionable information to other departments. When it comes to measuring performance, a company needs 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 key performance indicators, 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 to circle the most important piece of information. Nine times out of 10, 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 a 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 a business could monitor revenue every day, instead of every month, it could put a process in place or try to change the behavior to adjust the current trajectory.
As the role of the finance department evolves, businesses need to reassess outdated, inefficient processes like reporting. According to Bernard Marr of the Advance Performance Institute: "Key performance indicators 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.
Paul Yarwood is CEO of Insight Software, a provider of real-time financial reporting, planning and analysis tools.