What are Key Performance Indicators?

Our blog today is a conversation with our Financial Collaborator in Chief; James Phillipson at Mastermind Solutions, who provides fractional CFO services to mid-sized businesses.

PP: “James, when you think about Key Performance Indicators (KPIs) does your mind go to those fundamental measures that let the CEO know whether the business remains on track with her planned, or dare I say hoped for, trajectory.”

JP: “Yes absolutely as CFO, particularly where the business wants to grow and improve, you start off by agreeing a number of measures that will track progress. In other words the effectiveness of operational actions and activity”

PP: “What might they be?”

JP: “They could be traditional financial measures such as ROA, EBITDA or liquidity measures, such as Debt to Equity ratio, or interest coverage. They should also include operational metrics e.g. Head count, margin, sales, production, customers, employee engagement etc. They should be measures tailored to the businesses’ profile and objectives. Hugh Latif talks to this in a recent article in the “Globe and Mail”

PP: “Got it. So from a financial and operational perspective these are like a map to guide the journey?”

JP: “Exactly. What doesn’t get measured doesn’t get done. If a business wants to improve what it is doing or change direction, then it needs to establish a framework that will enable it to chart progress. A reliable technique is through regular comparison to budgeted KPIs, those achieved in prior periods and/or to industry standards, where they are available.

The most important benefit from working with KPIs is analysis of the variances – the detailed reasons why they are favorable, or otherwise. The Controller’s role is to provide this analysis and insight usually including graphs and commentary, so changes to process can be made by management based on the learning.”

PP: “In the HR world when we talk about performance measurement we sometimes find it difficult to attach measures to goals”

JP: “It is no different for finance and operations but when you get right down to it everything can be mathematically measured”

PP: “How would you go about measuring the ROI on say training, for example?”

JP: “First and foremost I would ask what the training is meant to achieve and what were the expected outcomes. Let’s say the training program is to improve skills or dexterity in the use of a new app or machine. What is the equipment designed to do and why is performance substandard now? What were the outcomes prior to training and what should they be afterwards. In other words, the measure is a proxy, that provides an indicator of the value of the company’s investment in training”.

PP: “So when you think of KPIs you think of measures that are elemental indicators of the organization’s ongoing health – rather like a thermometer and a blood pressure meter – and of course, regular financial reporting”

JP: “Exactly but also they could refer to important one-time events e.g. a target date for opening a new branch, or how many people attended an event that we hosted: and then later, how many new customers did it yield?”

PP: “Now that’s closer to how the HR community thinks about KPIs – milestones on a journey to achieving an important strategy. We would use them to set performance targets and to measure achievement against those targets and to help identify where professional development might be required”.

JP: “… and to determine pay!”

PP: “Absolutely. Performance against KPIs could be used to determine changes to base pay or the amount of incentive that is payable. Some organizations shy away from individual incentives and reward group effort. In those cases perhaps they should be using performance targets based on those “fundamentals” that you mentioned earlier.”

JP: “Best business performance includes maintaining existing standards at the same time as advancing improvement initiatives so why not measure and reward both. A department manager could have an efficiency metric such as throughput of the department but for a senior executive, gross margin percentage or ROA might be more appropriate”.

PP: “More companies today attempt to include qualitative criteria in keeping with their culture and values; “how” goals are achieved as well as “how much”. It is not hard to identify when a target has been met but it is not so easy to assess the degree of performance below or above target or for example, what is a minimal acceptable level and whether there should be a maximum achievement to discourage excessive activity that might harm future endeavor.”

JP: “That’s why it is always important for HR to collaborate with the CFO when setting performance metrics especially when compensation is at risk”.

PP: “That’s a good take away. Thank you James”.