I normally begin with a “Quote of the Week,” but I wanted to talk about Key Performance Indicators (KPIs) and didn’t really have an appropriate quote for that topic. So I guess this is a “Tip of the Week.”
While monthly financial statements provide vital information to the management of a business, they have a significant flaw: they are ancient history by the time we get them. There’s not much we can do about events that shaped our financial condition when those events happened four, five or six weeks prior to our seeing the financial statements. So we really need an early warning system . . . quick snapshots so we can see, on a weekly or even daily basis, how the business is performing in key areas. These are Key Performance Indicators or KPIs.
KPIs are different for every business, but there are a few that are fairly universal. For instance, many businesses track sales on a daily or weekly basis to make sure sales are on pace to meet that month’s goal. Cash flow is critical to all businesses, so virtually all of them will watch how efficiently and effectively they are able to collect their receivables.
Then there are KPIs that are not necessarily universal. If you are a wholesaler or a distributor, you probably need a KPI to make sure inventory levels are where they should be. If you are a manufacturer, you might need a KPI to watch waste levels, or another one to watch manhours per unit produced. A service business, on the other hand, may not have inventory or waste to worry about. It may be more concerned about billable hours vs. non-billable hours, or how many proposals are going out the door per day or per week.
The point is, you need to understand what indicators are the most critical to diagnosing the health of your business. And you shouldn’t need a lot of them. If they truly are “key” indicators, you shouldn’t need more than six or eight of them. Think of it like this. Suppose you’re on vacation. You’re having a great time and you would really like to stay a few more days than you originally planned. But before you do that, you better call the office to see how things are going. When you make that call, you can ask six and only six questions to determine if you can stay a few extra days or if you need to hop the next plane home. Those questions are your KPIs. They are not intended to tell you how every last detail of the business is performing. They are only intended to tell you that the most important parts of the business are performing within tolerances, and that the business is not in any imminent danger. If the patient has a hang nail or a sore throat, that’s OK. We need to address those ailments, but the patient isn’t going die from them. But if the patient’s heart is showing danger signs . . .
KPIs can be great tools to spot and address problems early. Used correctly, they can be one of your most powerful management resources. If you want to learn more about how to use them, pick up a copy of Kraig Kramers’ “CEO Tools.” He discusses KPIs at length, in easy-to-understand terms.
