However CFOs, CEOs, and other executives should ensure they are using a mix of both lagging and leading KPIs to understand how the business is performing currently, as well as how it may perform in the future.
Consider two cellular communication companies. Company “A” closely monitors the number of new subscribers it has added each month and makes revenue forecasts and infrastructure investment decisions based on this. Company “B” tracks the number of new subscribers it has added each month, but also closely monitors customer churn and customer satisfaction metrics. They factor all of these metrics into their forecasts and investment decisions. Which company do you think has the more accurate forecasts? Which ones makes more efficient use of their capital?
Metrics, KPIs, and Scorecards
A key tool in EPM is the concept of metrics or KPIs that help management focus on how the organization is performing against pre-defined, critical goals and objectives. These can be communicated or published in reports, dashboards, or scorecards delivered in print or electronically to executives and managers. Here’s a list of typical Finance KPIs:
- Days sales outstanding (DSO)
- Return on equity (ROE)
- Working capital
- Debt to equity ratio
- Inventory turnover
- Gross profit margin
- Net profit margin
Outside of Finance, management metrics and KPIs will vary based on the department and industry. Human Resources may be tracking things like employee turnover, while Sales is tracking pipeline and coverage ratio. A telecommunications company may track customer churn, while an oil and gas company tracks return on exploration costs.
Best Practices in Defining KPIs
In today’s world of “big data,” there’s more information available than ever. Both Finance and operating managers are becoming more metrics-oriented in how they manage their piece of the business. But are they tracking the right KPIs and metrics? What’s the best way to define your KPIs?
The Balanced Scorecard methodology, first defined by Robert Kaplan and David Norton in 1992, prescribed the development of metrics or KPIs across four perspectives: financial, customer, business process, and learning & growth. As the Balanced Scorecard methodology evolved, the concept of a strategy map was added as a way for managers to identify cause-and-effect links between strategic goals and KPIs.
There are other methodologies that define KPIs. Many consulting firms and management gurus have published articles and books on KPI development. But they all have common themes:
- Use a combination of financial and non-financial KPIs
- Ensure they’re timely (i.e., daily, weekly, monthly, quarterly)
- Ensure they’re actionable by management
- Ensure they’re significant, tied to specific goals and objectives
- Use a mix of leading and lagging indicators
Lagging vs. Leading KPIs
In today’s fast-changing business environment, having both “lagging” and “leading” KPIs is important. Lagging KPIs focus on what happened in the past. It’s like looking in the rearview mirror of a car or watching the odometer to see how far you’ve gone. Leading indicators focus on the future. What’s my current speed? What’s my fuel consumption? How many miles can I go with current fuel? What time will I arrive? You can make decisions based on these KPIs, decisions that will impact the outcome.
Most financial ratios and metrics are “lagging” indicators – they look at the past and current position. Leading indicators are tougher to capture and measure – but they’re far more valuable. Decisions made based on them can lead to improved future performance. Here’s a few examples of “leading” indicators:
- Sales orders or leads – leading indicator for revenue
- Customer satisfaction – leading indicator for propensity to buy or renew
- Employee engagement – leading indicator for employee turnover
- Supplier lead time – leading indicator for delivering on future orders
View from Ian Charles – Host Analytics CFO
I recently had a conversation with Host Analytics CFO Ian Charles to get his views on leading indicators for Finance. Here’s what he had to say:
John: Ian, do you view KPIs and metrics as a key part of EPM?
Ian: Absolutely. The whole idea of enterprise performance management requires measurement, so indicators are key to this. Organizations need to track performance vs. plan for different functions – sales, bookings, collections, customer service, etc.
John: How many KPIs do you track at Host Analytics?
Ian: We track over 70 KPIs that span Finance, Sales, Marketing, Services, and Support. Finance needs to have visibility into KPIs across all functions since many operational KPIs impact the financial results. But there are another 30 KPIs that are tracked by other operating executives that we don’t necessarily focus on. Examples include customer support calls, open cases, and engineering metrics that don’t impact Finance.
John: How do you select the KPIs that Finance tracks?
Ian: We start from a list of existing KPIs that are important to SaaS companies in general. Then we modify or decompose some of these and add sub-metrics that provide more insights into what’s happening in our business.
John: Can you give examples of forward-looking KPIs that you leverage as CFO?
Ian: Sure. Some examples include the Sales forecast for annual recurring revenue (ARR), bookings, pipeline creation, lead conversion rates, pipeline movement. We also look at product usage and capacity utilization trends in our technical operations. Customer satisfaction could be an early warning signal to future renewals, but it’s somewhat backward-looking.
John: Do you have any advice for other Finance executives in selecting KPIs?
Ian: Yes, a few thoughts here. First, Finance should be tied into big data and the operational metrics across the enterprise that impact Finance. The CFO needs to be “eyes on” all metrics. Second, every business is different, so the KPIs will vary based on what’s strategic. If cash flow is important, then metrics around cash and collections are critical. If returns on cash are critical, then investment returns and risk levels are key. KPIs should be driven based on an organization’s strategic objectives – such as customer acquisition, hiring & staffing, cost reduction, revenue growth, or others.
So there you have it. Some general guidelines on KPI selection based on industry best practices, as well as real-world advice from the CFO of Host Analytics. Contact us to learn how Host Analytics Cloud EPM Suite can help your organization capture and communicate metrics and KPIs to managers.