Do you know how well your business is performing? Many business owners believe the answer to this question is “yes”. However, as your company grows it may be more of a challenge to consistently assess business performance. You will want simple meaningful measures which can be communicated with staff and shared across your managerial team. This is where Key Performance Indicators (KPIs) fit in.
In this introductory guide, we break down what KPIs are and why they’re important, what makes a good KPI, and some of the main areas that are commonly measured.
What are key performance indicators?
Put simply, KPIs are measurable values that can be used to assess the performance of a company or its activities. They can be a powerful tool to determine how effectively your business is achieving its objectives, and are displayed in a clear, concise numerical format.
KPIs promote transparency within a company, and allow all employees, not just management, to track your company’s progress. As the essential data they provide can be used to facilitate decision-making, the right KPIs can be critical to driving the growth of your business.
The types and applicability of KPIs are varied, and range from high-level KPIs assessing the performance of the business as a whole, to lower-level KPIs which evaluate the performance of projects, departments or individual employees.
What makes a good KPI?
With thousands of KPIs to choose from, the first step is to identify the most important ones to your business. The nature of your KPIs and how many you have should be relevant to your business model and the industry you operate in, as well as other factors such as your company’s stage of growth.
Above all, a good KPI will be linked to your company’s pre-set goals and objectives to give you the actionable data necessary to support decision-making, so it’s important to have your goals firmly established before you start developing your KPIs.
Regardless of which particular metrics you decide to use, there are some general characteristics that all good KPIs have:
Simple. To be effective, KPIs should be easily understood across the organisation. Your staff need to know exactly what the KPI is measuring, how to calculate it, and what they can do to influence that figure and achieve the best results. For this reason it’s better to use a select few metrics that are essential to your business, rather than losing focus and relevance with too many KPIs.
Measurable. A KPI can be either quantitative or qualitative, but it should always measure your progress towards your business’ goals in clearly-defined terms.
Achievable. A good KPI will motivate staff to improve aspects of your company’s performance, so it’s important that they are set against objectives that are aspirational but not unattainable.
Time bound. KPIs should indicate your business’ progress towards its objectives over a specified and relevant time frame. They also need to be measured on a regular basis; assessing your KPI performance periodically will allow you to track your progress accurately and identify opportunities to improve.
Four main areas for KPIs
These are some of the key areas to think about when developing meaningful metrics for your business, and some examples of commonly-used KPIs which fall under these categories.
It’s essential for a company’s leadership and finance department to have a good view of its numbers and be able to responsibly manage its finances. Financial KPIs are typically focused on a business’ generation of revenue and profitability, but are by no means limited to these measures. Here are a few of the top metrics that can be used to gauge your business’ financial health:
Gross profit margin. This measures the amount of money remaining after you’ve deducted the cost of goods sold, giving you an insight into how efficiently your business is producing and selling its products. It is calculated by subtracting the cost of goods sold (COGS) from total revenue, then dividing by the total sales revenue.
Net profit margin. This tells you how well your company is doing at converting revenue into profit. It’s the profit remaining after you’ve subtracted all operating expenses, taxes, interest and depreciation, divided by the total net revenue to give a percentage.
Current ratio. This KPI, calculated by dividing current assets by current liabilities, can be used to assess your business’ ability to pay its short-term financial obligations.
Operating cash flow (OCF). This measures the total amount of money generated by your core business operations by subtracting operating expenses from total revenues.
Acquiring and retaining customers is a key component of growing a successful business. Here are some customer KPIs you might consider using to assess whether you’re bringing in and satisfying customers effectively enough:
Customer acquisition cost
This measures the cost incurred in convincing a new customer to make a purchase. It can be calculated by adding up the sales and marketing costs for a given time period, and dividing this figure by the number of new customers for the period.
Customer retention rate
The customer retention rate shows the percentage of customers your business has retained over a specific time period. One way to determine this is to take the number of customers at the end of a given period, subtracted by the number of new customers acquired over that period, and divided by the number of customers at the beginning of the period.
Customer churn rate
In contrast to the customer retention rate, the churn rate is the percentage of customers you’ve lost over a given period. To calculate this, you can divide the customers you’ve lost within a certain time frame by the number of customers you had at the beginning of the period.
There are a wide variety of KPIs that can be monitored to help ensure that a business is operating as productively as possible, including:
This is one of the most commonly-used KPIs for businesses that bill their clients by the hour. Generally, a higher percentage of billable utilisation reveals how fast a business is growing and how profitable the company is.
Calculating billable utilisation involves dividing the total hours worked by the company’s employees by their total billable hours to provide a clear, percentage-based indication of financial productivity. This can then be used to compare an individual’s performance with pre-established targets, both personal and firm-wide.
Capacity utilisation rate
Capacity utilisation rate is an important measure of operational efficiency and is most easily applied to companies which produce goods rather than services. It shows the extent to which your company is using its full productive capacity, and from this you can deduce how much capacity you could still utilise. To work this out, you divide the actual output in a time period by the potential capacity in a time period.
Overall equipment effectiveness
This is one of the top KPIs for measuring manufacturing productivity. It involves taking the availability, performance and quality rates of the manufacturing process and multiplying these together to give the percentage of scheduled production time that is fully productive. This can help you identify areas in which you need to improve; for example there may be too many defects or too much downtime.
To get a better understanding of your recruitment process, employee performance and work environment, there are various people metrics that can be used, such as:
Revenue per employee
A useful indicator of your staff efficiency when compared against competitors in your industry or analysed over time, revenue per employee is a ratio that is calculated by dividing your total revenue by your current number of full-time employees.
Employee turnover rate
This is a key metric for employee retention, and is worked out by taking the number of employees who left the company during a given time frame and dividing this by the average number of employees for the period.
Time to fill
This is the number of days between the publication of a job vacancy and the acceptance of the job offer, figured out by adding all the time to fill days for every position you’ve filled within a period, and dividing by the number of roles. It can help with business planning and allow you to identify when your recruitment process is taking too long.
Whether you’re a start-up or an established business, having a KPI system in place is invaluable for improving your business processes and driving growth. For more business advice and guidance, visit the Business Wales website here.