KPI is the acronym for Key Performance Indicator. A catchy name for sure, but what are KPIs, and how are they used to achieve the absolute best performance? First, let us look at what KPIs are not.
KPIs are not the win/loss column in the sports pages. They are not your net worth. They are not your company’s financial statements or your company’s financial ratios. All of these are standard measures, of which KPI’s are not. KPIs are discretionary measures that are used to move the standard measure needles.
Another measure that gets confused with KPIs are OKRs which are Objectives with Key Results. Similar to KPI’s, OKRs are discretionary however, OKRs expire when the objective being tracked is achieved. KPIs do not expire. They cycle from one measurement period to the next.
KPIs are mandatory for companies to achieve their absolute best financial performance and KPIs need to be designed to manage both a company’s overall performance and for each team and individual.
Measuring Performance
Overall, performance KPIs are those that drive a company’s value proposition, which is defined by the company itself or the industry in which the company operates. Take the NHL for example. There is one component that has the most significant effect on the won/lost column. Speed. If a player cannot keep up, there is no place for them in the league. Of course, if speed were the only skill a player needed, teams would only draft speed skaters. However, speed is so important these days that it is a significant KPI of overall team performance. Player speed and team speed are monitored every time a hockey game is played.
KPIs, in most cases, is a more immediate measure of performance than financial statements and financial ratios. The faster the measure, the faster the feedback. The faster the feedback, the faster the corrective action, and therefore the faster the performance improves. Their immediacy is what makes KPIs so necessary and powerful. Although KPIs do work hand in hand with financial statements and financial ratios, the role of KPIs is to maintain or improve the standard financial statement and financial ratio measures.
KPI Example
An illustration of how KPIs work with financial statements and financial ratios is the management of accounts receivable. Companies that sell on credit will have accounts receivable on the balance sheet of their financial statements. A financial ratio related to accounts receivable is DSO – Days Sales Outstanding. The lower the DSO, the better. DSO’s formula is Average Accounts Receivable for a Period / Revenue for a Period x 365 Days.
So, what is the KPI that will maintain or lower a company’s DSO number? This depends on the company’s situation and circumstances. For some companies, the KPI will be the monitoring of the credit-granting function. Other companies may only sell to investment grade accounts, so the credit-granting function is not crucial to DSO. However, these companies may have a complex billing and invoicing process if they sell time, equipment, and material services. Therefore, the time to prepare bills and invoices is the relevant KPI for this company.
Alternatively, some companies may serve a market where their customers generally have a lower credit rating and need a prompt before paying their invoices. In this situation, the KPIs relevant to DSO will monitor the credit-granting function and the collections function.
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