Financial Planning & Analysis

KPI Development Tips for Effective Enterprises

8020 Consultant Mitch Browne has over 10 years of diverse finance experience, including positions in corporate strategy, corporate finance and investment banking. Prior to joining 8020 Consulting, he served as the acting Director of Finance at AECOM, where he led the annual operating planning process and long-range strategic plan and contributed to the firm’s $6 billion acquisition of URS Corporation. He has also held corporate finance positions at Yahoo and Hulu. Earlier in his career, Mitch was an Investment Banking Associate at Wells Fargo and Hadley Partners, where he represented middle market companies in the consumer products, restaurant and professional services sectors. He holds a BA in Economics from Claremont McKenna College and will receive his MBA from Washington State University in early 2016.

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We asked Mitch to share a few tips and best practices regarding the creation, implementation and monitoring of key performance indicators. While most companies are on the right track when it comes to KPIs, quite a few are still missing the mark and negatively impacting their financial planning & analysis efforts. Overall, establishing clear enterprise goals, alignment amongst top management and narrowing the focus to a few high-priority KPIs are key.

 

Q: What should a company’s overall goals be in creating and monitoring KPIs?

A: New KPIs should serve to guide to senior management focus.  They should help management establish a scorecard or provide a yardstick by which to measure their performance throughout the year. For that to happen, companies first need to establish their enterprise goals. Overall, you’re trying to establish measurable outcomes that will allow you to guide and assess the performance of management in light of your current goals.

Most companies get much of this right. They have a rough idea of their goals, and they know what metrics they’ll need to track to accomplish those goals. Still, problems occur when a company’s business strategy isn’t clearly and specifically defined. Senior management needs to know exactly what the board is charging them with achieving.

 

Q: What are some of the most common pitfalls concerning KPIs? Where do most companies go wrong?

A: First, some companies establish too few KPIs. This isn’t the biggest problem, but there are situations in which organizations will focus far too much on one metric at the expense of others. An example is putting all focus on revenue growth. While that may be the most important metric for many companies, you want to be sure you’re not growing revenue at the expense of everything else. A company might focus too much on revenue and achieve that target, but by that point they’ll have ignored other key metrics like profitability.

A far more common problem is the establishment of too many KPIs. Most of these indicators are well-intentioned, and when evaluated independently, they’re very useful. But when you give a management team or employees too many goals, it becomes difficult or even impossible to determine which goal should be the focus at any level of the organization. The laundry list distracts the management team from targeting the core KPIs that will generate the biggest impact on the business.

Another frequent problem is the inconsistent application of well-thought-out KPIs. This often results from different leaders being given different ideas about which KPIs are most important. For instance, senior management might tell one group to focus purely on cost as a percentage of sales, another group on overall sales growth and another still on optimizing working capital. Each of those KPIs may have merit in and of itself, but they can easily conflict one another. You need to make sure that all of the KPIs by which leaders’ performances will be evaluated are in harmony.

Finally, many organizations aren’t able to practically apply their KPIs, often because they don’t have the systems in place to track necessary metrics. For example, if you’re tracking working capital, you might not have a clean balance sheet for every entity you want to evaluate. You’ll have to think about how to make estimates or allocations that give reasonable insight into the working capital of different segments, different countries and different areas of the business. Similarly, looking at gross margins – a common KPI – problems can arise if you don’t have the appropriate systems to track products by product group, division or region. The theory might be fine – you’d like to track gross margins of product X in markets A, B and C – but you have to have the right reporting systems in place.

 

Q: How should companies choose the most important KPIs for their needs?

A: First, they should clarify their goals. For instance, are they focusing more on revenue growth, capital management or lowering costs relative to sales? These are all important goals at one point or another in a company’s lifecycle, but management needs to be clear about which ones take priority over others.

Second, they should identify the specific indicators that will track the company’s performance in achieving those goals. These indicators may vary by department or region, and several different metrics often feed into the same goal. It’s also important to keep the list of KPIs as brief as possible, so you don’t lose focus.

Finally, you need to be aware of how different KPIs used by different departments within a company interact – and possibly conflict – with one another. You need to make sure there’s not a conflict between individual departments’ goals and the goals of the company as a whole. One of the best approaches I’ve found to accomplish this last task is to establish an ROI-focused metric – a calculation that incorporates multiple financial metrics into a single KPI.

 

Q: How can companies create that kind of ROI-style metric that applies throughout their organizations?

A: There’s no quick and simple way to implement that kind of metric, but generally what needs to be achieved is the identification of the numerator – representing revenue and profit – and the denominator – representing working capital and the balance sheet. There are several nuances in making both sides of that equation appropriate for a given business, but if you can pin them down, the resulting metric is a powerful tool for measuring performance across the enterprise.

 

Want to learn more?

KPI development is only the first step to enterprise success. To make progress toward your organizational goals, you’ll need a focused organizational review program. It can help your company gain and keep traction on enterprise goals. You can get our free guide to learn more.

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