When you climb behind the wheel of your car, you’ll see a row of gauges on the dashboard with needles that give advance warnings of potential problems with oil pressure, engine temperature and other measurements. Such gauges enable drivers to spot signs of potential danger at a glance and take corrective action.
Like car owners, business owners should monitor gauges on their business dashboard that will give them a heads-up about financial problems lurking down the road. These financial gauges usually consist of measurements that reflect the company’s key success factors, or key performance indicators (KPIs).
KPIs differ from one company to the next based on the industry, type of business — business to business or business to consumer, for example — and, most important, the company’s objectives. Your KPIs will stem mainly from your mission statement and your short-, medium- and long-term goals.
Measuring the Financial and the Nonfinancial
There are two broad categories of KPIs: financial and nonfinancial. Financial KPIs often take the form of ratios, such as the current ratio, the debt-to-equity ratio and days sales outstanding. (See the section at the end of this article “3 Important Parts of Every Dashboard.”)
Nonfinancial KPIs may include measurable business metrics in the areas of customer service, sales, marketing and manufacturing. Here are some examples:
If a company’s goal is to improve its response time to customer complaints, its KPI might be to provide an initial response to complaints within 24 hours, and to eventually resolve at least 80% of complaints to the customer’s satisfaction.
If a company wants to improve its closing rate on sales leads, its KPI could be to convert 50% of all qualified leads into customers over the next six months, and 60% over the following six months.
Notice that each of these KPIs is both specific and measurable. Just saying that your company wants to “provide better customer service,” “close more sales” or “reduce waste” doesn’t produce a sound KPI.
Benchmarking Your Data
Some basis of comparison for your KPIs is also important. A 50% close ratio or 1% unit reject rate might be good, but compared to what? Benchmarks will provide a standard against which you can compare your KPIs to see how they stack up against previous periods or the averages of other companies in your industry. Doing so will enable you to view your KPIs in the proper perspective.
Bear in mind that some formulas have slightly different versions. It’s important to know which formula is being used when comparing your results to those of other companies.
Start by benchmarking your KPIs from one period of time (for example, a quarter or year) to another. This will help you spot trends pointing to future problems so you can deal with them before they actually arise. If your accounts receivable days are lengthening, for instance, this might indicate that your collections are lagging and a cash flow crunch is looming.
For industry financial benchmarks, consult the Risk Management Association’s Annual Statement Studies®. This publication contains industry averages for financial ratios and metrics for hundreds of different industries. Visit http://rmahq.org/tools-publications/publications/annual-statement-studies/annual-statement-studies to order the publication — or check with your industry trade association or area library for a copy.
Incenting your employees
Your KPIs should be shared with anyone in your company whose performance will impact them. You can even create performance incentive programs that are based on achieving KPI improvement goals. Again, it’s critical to make your KPIs both specific and measurable, and to provide your staff with regular updates about how well the company is doing.
Important Parts of Every Dashboard
In creating his or her dashboard, just about every business owner should concentrate on three important areas:
1. Growth. Hey, who doesn’t aspire to growth? But, if not planned for and controlled, companies can literally grow themselves right out of business. To manage your growth, monitor:
Debt to Equity: Total Debt / Shareholder’s Equity, and
Debt to Tangible Net Worth: Total Liabilities – Debt / Net Worth – Intangible Assets + Debt.
2. Cash flow. Poor cash flow, not slow sales or lagging profits, is one of the leading causes of business bankruptcy. To help circumvent future cash flow squeezes, keep a close eye on:
Current Ratio: Current Assets / Current Liabilities, and
Days Sales Outstanding (DSO): Number of Days × Accounts Receivable / Credit Sales.
3. Inventory. Many companies waste valuable cash by allowing slow-moving inventory to sit idle on their shelves for too long. To more carefully watch your inventory, track:
Inventory Turnover: Cost of Goods Sold / Average Inventory, and
Average Days to Sell: 365 / Inventory Turnover Ratio.