Key performance indicators Featured

8:00pm EDT May 26, 2008

If you don’t know how your business is doing at all times, you’re headed for trouble. An early warning system? Clearly defined key performance indicators (KPIs).

“A key performance indicator is a metric that allows you to evaluate whether you are meeting a certain goal,” says James P. Martin, CMA, CIA, CFE, CFD, CFFA, a senior manager with Cendrowski Corporate Advisors LLC. “Identifying what the KPIs should be for a particular organization is part of the overall risk assessment process, which identifies any number of factors that can stand in the way of success.”

Smart Business spoke with Martin about how to effectively use KPIs to monitor whether your business is on track.

How important are metrics?

Very. If a KPI is not measurable, it will not be useful. For example, ‘word-of-mouth’ is not a useful metric. And, make sure you measure things that are relevant. Here’s an example: By using metrics, an organization named pets.com — which sold bulk pet food and the like on the Internet — determined that many shoppers were abandoning their carts at the time of checkout. Why? Because most of the products were too expensive to ship as opposed to simply buying them in the store. Pets.com went out of business because their solution was to provide free shipping. They used a metric that revealed a problem with their business model, but incorrectly interpreted it.

So how can a company best define relevant key performance indicators?

Performance indicators differ from business to business. Having clearly defined goals to start with will help the company determine what it needs to monitor. To assist in the process, use the SMART acronym; ask whether the KPI is Specific, Measurable, Achievable, Relevant and Time-bound. A KPI should be all of these.

How can this information then be used to improve efficiency?

Key performance indicators are used in many industries to monitor and improve efficiency, and thus improve the bottom line. The fast-food industry has the use of KPIs down to a science. It monitors everything — how long it takes you to receive your food, how long it takes to cook 100 burgers — the list goes on. The industry knows what needs to be accomplished to achieve its goals, and identifies a measure to make sure it happens.

Another example is a call center. Management will monitor how many people it takes to answer how many calls per day to determine ways it can improve efficiency.

And how often should a company monitor its KPIs?

It depends on many factors unique to each organization. If you’re a company in turnaround mode with low cash levels in the bank, you might be monitoring certain KPIs daily, such as A/R and average sales per day. If you’re a manufacturing company tracking production on a piece of equipment you’ve financed, maybe you are analyzing the metrics on a monthly or quarterly basis.

How would something like a ‘balanced scorecard’ play into the equation?

That means that you have to look at overall objectives holistically. If you only measure factors related to profit (e.g., how many widgets can we produce by how many workers in one hour) you might overlook quality, marketing — all the other elements that must work in harmony in order to achieve success. Your KPIs should be setup so that you are monitoring all areas of the business that tie into achieving your overall goals.

What about companies that don’t have KPIs in place; how can they get started?

They do have KPIs in place; they just may not realize it. For example, they intuitively monitor payroll — they know how many hours they pay versus periodic revenue. The first step to formalizing the process is to determine what you need to monitor and measure. Look at the current performance, benchmarks and target levels. Think about all the processes you undertake; analyze objectives and risk conditions/pitfalls to avoid.

Can accounting software make the monitoring job easier?

The monitoring of KPIs is nothing new — we’ve been doing this manually for centuries. The prevalence of computers and today’s accounting software just provides readily available information. Today’s software enables companies of all sizes to create risk models, define data criteria, set early warning triggers and alerts, etc.

How often should KPIs be revisited?

At least once a year, as part of the annual meeting to set objectives for the upcoming year. Throughout the year, new KPIs may need to be added and old ones, removed. To be useful, the KPIs that are already in place must continue to make sense.

JAMES P. MARTIN, CMA, CIA, CFE, CFD, CFFA, is a senior manager with Cendrowski Corporate Advisors LLC. Reach him at (866) 717-1607 or cs@cendsel.com or go to the company’s Web site at www.frauddeterrence.com.