Using KPIs can give you better business insight
Doctors use KPIs to measure our health and wellbeing. Our body mass index (BMI), blood pressure and cholesterol level are all KPIs that have a specific medical meaning. In the same way, business KPIs carry specific meanings too. Debt/equity ratio, accounts receivable days and gross profit percentage are all measures that have specific meanings in a business context.
Key performance indicators are used by businesses of all sizes. KPI measurement uses data to show how well your business is performing. They will be different for each business, but the basic idea is the same. That is, to measure the important features of your business.
On its own, your blood pressure reading only says a little about your overall health. When you combine this with cholesterol levels and BMI, you and your doctor get a more informed picture of your health. In the same way, a business KPI tells a small part of the story about your business. Looking at a set of business KPIs or metrics tells a bigger story. You can use that knowledge to make effective, strategic decisions.
Choose what you measure with care
Think carefully about which areas of your business are suitable for measurement. Different sets of metrics are important for different businesses. Focusing on the right ones gives you early confirmation of success or early alerts to potential problems.
Your accountant will be able to help you decide which are the important KPIs for you. When they advise you about this they will consider:
- the industry that you are in
- your business size and location
- where you are in your business life-cycle
- what your short and long-term business goals are
- any unique personal circumstances you have
What does a KPI look like?
A KPI is a metric, which means it's a way of measuring your business. To be effective, it should be:
- Relevant: The best metrics are those that have the most impact
- Balanced: Measure short and long-term KPIs
- Understandable: Everyone in the business should know what the KPI means
- Shared: Everyone in the business should know why it’s important
Financial KPIs come from the data in your accounting system. Non-financial KPIs come from data outside of your accounting system, such as your website and your CRM system. This guide focuses on financial KPIs.
Here are examples of what you might measure:
- Accounts receivable days
- Average margins
- Inventory turnover
- Debt ratio
- Net profit percentage
Identify the key areas you want to measure
If you're measuring key performance indicators then you need to concentrate on your key areas of business. There's no point in measuring things that won't make a difference to your business over time.
How many KPIs should you measure? It depends on your business. Small businesses may only need half a dozen or so. Larger organizations might have that many per department – or even per manager.
More doesn't necessarily mean better, so don't get carried away. Too many metrics can complicate the picture. Make sure you have just enough to give you a clear overview of your business. Your accountant will be able to help choose the ones most relevant for you.
Understand what your metrics are telling you
KPIs are useful tools to help you measure the performance of your business. But you need to use them sensibly. Don't just take them at face value.
A sales dip recorded by a KPI might be due to seasonal variation. For example, people don't buy much winter clothing in summer. There's not a lot you can do about that – it's not the fault of your sales staff.
Similarly, inventory turnover might drop because you bought lots of inventory while a supplier had a sale. Normally a drop in inventory turnover would be a bad thing. In this case, you would monitor inventory turnover to check that it returns to normal as you sell the surplus inventory.
So it is important to understand what KPIs are telling you before you try to solve a problem. If you use common sense, key performance indicators are useful tools. Again, your accountant can really help out by interpreting the message the metrics are giving you.
Four KPI groups to improve your business
Effective key performance indicators can be organized into groups. Here are four groups that could have a big impact on your business.
- Reducing waste and making the most of your resources
- Finding ways to improve staff productivity
- Lowering inventory days on hand to reduce storage costs
- Increasing your sales, measured by gross and net revenue
- Improving wealth, measured by business equity
- Balance debt and equity levels to the best proportions
- Balance inventory levels with trade payables to get the best performance
- Optimizing trade terms to speed up receipts
- Reducing credit risk by optimizing debt levels
- Improving profitability to increase interest coverage
- Reducing financial risk by increasing equity-to-asset levels
These are just examples. No doubt you can think of others that might apply to your particular business.
Remember, you can use modern accounting software to track some of these KPI groups. And if that software is cloud based, you can keep an eye on your KPIs from anywhere and at any time.
Get a better view of your business
As you can see, key performance indicators are useful in all areas of business. But it's important to use them in the right way and not just define a KPI and then forget about it. Make sure that whatever you choose to measure is reviewed and tracked on a regular and frequent basis.
KPIs will help you get a clear view of where your business is now – and where it's going. Used properly, they help you take the pulse of your organization's health.
Disclaimer: Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the provided content.