Key Performance Indicators (KPIs) are quantitative business metrics that are used to track the performance of business towards its objectives. They are basically used to monitor the
company’s progress and how far a company is successful in executing its strategies.
Choosing a good set of KPIs is very crucial for any business for effective and right decision making. Financial analyst’s skills play a major role in selecting the right set of KPIs for a company. Every business is not suitable for all type of KPIs. While selecting the right KPIs,
financial analyst must first study the nature of business, its industry type, objectives of business and its short-term goals. An effective selection of KPIs will help the business in identifying the critical areas to be focused on.
Reasons for choosing the right KPIs:
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Alignment: A company needs to align its performance with its goal. For example, if a company is striving hard to achieve its goal of 15% increase in revenue, it could consider the KPIs such as Asset turnover ratio. This way company can monitor the right KPI in accordance to its goal.
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Streamlining: Goals or objectives of a company must be updated on timely basis. Every business has their own phases, some are at the introduction phase and some are at a maturity phase. The objectives that were made at introduction phase may not be same at a growing phase of a company.Hence, updating the objectives before selecting the KPIs is of utmost importance.After defining the objectives or goals, a company must choose an appropriate performance indicator.
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Identification: Identifying or detecting a problem area is an important task to be consider by a financial analyst. For an instance, if there is a drop in net profit in a particular year, it may happen because of a one-time expense that has incurred in that particular year. Thus, a proper interpretation of key metrics is important for detecting a problem.
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Decision making: Analyzing a pattern of KPI is important as it helps the company in effective decision making as including the historical data into a financial model will help in knowing the upward or downward pattern.
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Monitoring: Tracking the performance of a company is the main purpose of including the right KPI in the model. The performance measures are used in a company in diverse areas such as for production control, quality management or may be for receivable management. Thus, Key Performance indicators help in monitoring the performance of a company and identifying the key areas to be focused on for effective growth in future.
How to choose a right KPIs for your business
Choosing a right KPI is a critical part of any decision-making process. It basically involves the study of internal environment of a business. Following are some of the aspects to be considered while choosing the right KPI:
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Nature of business: Nature of business plays an important role while selecting a set of
KPIs. KPIs like Conversion rate, Customer Life Time Value, or Average Order Value are suitable for an ecommerce company but may not be suitable for a Pharmaceutical company. -
Who needs the KPI: Selection of a KPI depends on who is using a performance indicator. It can be CEO or a business leader or any other decision maker. Some decision makers prefer sharing all KPIs with employees and some may prefer sharing only the operational but not financial KPIs.
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Strategic goals: KPIs must meet the goal requirement. If the company goal is to reduce the stringent the credit policy, the Accounts Receivable turnover is a good metric to be considered.
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Leading and lagging indicators: There are two types of indicators i.e.,leading and lagging. Leading indicators are those indicators which provide us the forecast after the business activity has already occurred. On contrary, the lagging indicators are those indicators that shows performance of a company based on historical figures. For example, a decrease in production capacity of a plant which is a leading indicator may affect the revenue growth which is a lagging indicator. Hence, a financial analyst must choose the set of KPIs based
on its type while meeting the strategic requirements. -
Not all but specific: As I said earlier, all KPIs are not suitable for every type of business. The decision maker should select a set of KPIs meeting the business type and the strategic goals.
A company should select those KPIs which are aligned to the strategic goals. For company’s success identifying and selecting the right KPIs is an important part of decision making process. Performance indicators must be use for performance evaluation and necessary
changes must be done to pace up with the changing environment.