This Insights article was contributed by Chris Massey, CPA (NC License Number 39147), a tax manager at Adam Shay CPA, PLLC.
Early Chinese navigators may have been the first to use compasses to determine where Earth’s magnetic north was on a consistent basis (1). This gave them a distinct advantage in exploration and trade. Later, 15th Century explorers realized that Earth’s magnetic north was not the same as its “true” geographic north, a distance of 500 kilometers in early 2018 (2). While both are important, when using a compass for navigation, knowing where true north is in relation to the magnetic north was a critical component in carrying out accurate - and therefore profitable - voyages. This difference, called magnetic declination, is constantly moving making it more difficult to track and monitor.
Much like the advantages and challenges of knowing where true north is in navigation, using the right key performance indicators (“KPIs”) can help business owners navigate their own financial voyages.
Many business owners understand what drives sales but fewer business owners understand what drives their profitability. Even for businesses that have implemented KPIs, their view is largely one of monitoring the status quo instead of a commitment to intentionally drive changes and decisions. Strategically thinking about, implementing, and evaluating KPIs is a valuable process. By presenting information in a different format, businesses are forced to view financial issues and strategic objectives under a different lens. Doing so may provide insights into your business that may not have been self-evident in the past. These insights lead to enhanced decision making, mitigation of various risks (financial, liquidity, etc), and more effectively analyzing trends.
But what makes a KPI “key”? There is no boilerplate mix of KPIs, even for companies in the same industry. In today’s complex global economy, more businesses are offering various mixtures of products and services to their customers to gain competitive advantages. As a result, taking the time to develop KPIs that are tailored to your specific business model is time well spent.
A recent client experience demonstrated the importance of this. The company is a digital marketing agency. They focus on margins per project and have other financial metrics that they informally keep in mind when making decisions. However, through our processes we highlighted that the number of revisions per project resulted in better information regarding the margins per project. The fewer the number of revisions, the higher the profitability (i.e., negatively correlated). Whereas this might be expected, it is not always true. This helped them refocus their efforts and proactively look for projects least likely to have revisions (based on various factors).
That experience also demonstrated the importance of combining financial KPIs with nonfinancial KPIs that share some correlation. In this case it was margin per project (financial KPI) and number of revisions per project (nonfinancial KPI). Only looking at margin per project told them that something was wrong, but the average revisions per project told them why. Qualitative measures should also be considered such as degrees of quality or customer satisfaction.
An example of this combined qualitative and quantitative KPI focus, is the percentage of failed quality control tests and the cost of product returns. In this example, the KPIs are positively correlated. As the quality control failure rate increases, it is likely that product returns and/or customer dissatisfaction will increase.
After developing KPIs, businesses need a system to implement and monitor KPIs. The method we use to help businesses achieve this is through a digital dashboard. Essentially, it is a 1 page summary of a company’s financial well-being (using KPIs) at a snapshot in time. Owners can log in to quickly review their metrics for the week, month, quarter, etc. They can then use that information to guide their decision making for the upcoming period and reevaluate goals. This is all dependent on having a high degree of bookkeeping accuracy so that the data going in is quality and up-to-date.
Whereas business owners and executives will be closely monitoring KPIs and making decisions, the KPIs being tracked need to be shared across the company to achieve organizational alignment. Getting buy-in from all levels of the organization may be difficult at first, but is critical in the success of KPI implementation.
KPIs are only as valuable as the energy and effort of its users. The following 6 behaviors from a recent study by MIT Sloan Management Review (“2018 Strategic Measurement Global Executive Study & Research Report”) can serve as a framework for best practices (3):
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