Key Performance Indicators

Key performance indicators (KPIs) help a company evaluate its overall business performance against the set goals over a period. These can differ depending on the types of firm or industry and the assessment criteria. Also, most firms employ these indicators to stay ahead of the competition.

A company can have various objectives, such as financial, operational, and strategic. Using KPIs allows the organization to track progress toward these goals, understand business growth, and identify problem areas to achieve success. These also act as essential decision-making tools.

• Key performance indicators (KPIs) allow a company to assess its business performance over time compared to defined targets. They should be regularly reviewed and altered to ensure their relevance.
• These can vary depending on the types of company or industry and the evaluation criteria for financial, operational, and strategic goals.
• KPIs are essential for a company's capacity to plan for future improvements, make the best decisions, and predict outcomes and risks, among other things.
• The ability of management to gather, evaluate, turn data into relevant information and insights is critical to the success of KPIs.

The key performance indicators describe a set of metrics used by companies to track and measure their performance in terms of revenue and profit. The company's success depends on how well its projects, products, and other initiatives are doing. As a result, creating effective KPIs is crucial for a company to plan possible improvements, make the best decisions, forecast outcomes and risks of actions, etc.

A company can define KPIs to assess both its internal and external goals. For example, it can be evaluating the success within departments or the overall business. KPIs can be quantitative, qualitative, actionable, or practical based on their functions.

It is also worth noting that KPIs from one organization may not necessarily work for another because they have distinct goals, regardless of the industry. Therefore, a company must go through a series of stages before deciding on the optimum KPIs, such as:

• Defining business operations
• Setting process requirements
• Modifying processes to attain goals

The two most common KPIs are customer-focused and process-focused. While the former assesses customer efficiency, satisfaction, and retention, the latter gauges operational performance.

KPIs typically rely on data to measure the business performance concerning its objectives. The data can be either quantitative or qualitative. The following are some of the steps involved in developing KPIs to ensure process and operational optimization:

1. Setting Goals - It entails comprehending business activities, such as expenditures, revenues, asset management, etc., to define short- and long-term goals.
2. Establishing Critical Success Factors (CSFs) - It encompasses several tasks, such as the time required by an organization to achieve its objectives.
3. Developing Strategies - Businesses must ask pertinent questions to develop strategic initiatives, eliciting meaningful responses that direct attention to areas of improvement.
4. Collecting Data - Timely collection of the appropriate and quality data can aid in selecting the right performance indicator.
5. Deciding On KPIs - Each KPI answers a question regarding anything a company needs to know to improve the performance of a specific department. As a result, a set of KPIs provides a clear overview of all business areas.
6. Defining Targets for KPIs - Each KPI must have a target showing the intended level of performance of the company.
7. Calculating Metrics - The business can use percentages, ratios, or other numerical values to demonstrate its performance.
8. Analyzing KPIs - When it comes to assessing KPIs and turning data into useful information and insights, it is crucial to analyze them.
9. Reporting/Communicating KPIs - KPIs must be reported and communicated to those who need to know in a timely and easily understandable manner to aid decision-making.
10. Allocating Responsibility - The business must relegate responsibilities to individuals for strategic objectives highlighted under KPIs. The firm can contact the responsible person to discuss or improve performance in the future.
11. Reviewing KPIs Regularly - The KPIs should be reviewed regularly to know if they serve their intended purposes. If a KPI is not working, the company must change it or replace it with something better.

Let us look at one of the key performance indicators examples to understand the concept better:

Process-focused KPIs measure the overall operational performance of a company. For example, a toy company ABC develops the following KPI to achieve its goal:

Step 1: Objective – Increase the production of toys of superior quality

Step 2: Strategy – Reduce the percentage of defective toys

Step 3: Data source – Inventory or stock register and quality assurance register

Step 5: Target – Reduce the number of defective toys to 2% of the total production by the end of the year

Step 4: KPI formula – Defective Density (DD) = Number of defective toys / Total production x 100

If,

Total production from ABC during a quarter is 100,000 units

And the number of defects during the same quarter (as per stock register) is 4,000 units

Then,

DD = 4,000 / 100,000 x 100

= 4%

Step 6: Analysis – In this case, KPI is more than the target (KPI – 4% and Target – 2%). Therefore, it increases defective toys, resulting in worse quality toy production.

Step 7: Report/communicate KPI

The company reports its KPI quarterly.

Step 8: As evident from the KPI, the production department is an area that requires attention. The department must act on this information by finding and correcting faults in the manufacturing process.

Step 9: Review the KPI, if required

A company must communicate its KPIs to respective departments and employees to ensure everyone works toward the common business goal. It will, thus, result in improved corporate performance.

KPIs were previously measured manually. However, it is now much easier to collect, organize, and record data in real-time using advanced software for key performance indicators in project management. The numerical data generated by the software enable the company to assess its performance concerning its objectives.

A company must first comprehend the structure of a KPI to measure and report it. The following are the components of a KPI:

1. Data source – Includes surveys, questionnaires, documents, records, interviews, etc.
2. Formula – Create a new formula or pick an existing one.
3. Target – Desired level of performance in numbers and time frame to achieve it.
4. Frequency – Number of times a KPI is reported over some time.

After the company has defined all of the above data, it must calculate and assess the KPI value before comparing it to the target. It means:

• If the KPI value is close to the target, the company is progressing
• If the KPI value is way off the goal, the company needs to identify and correct the reasons behind this

KPIs highlight areas that need attention. It enables the firm to understand what is functional or faulty in a system to improve the business performance.

KPIs should be designed and used in specific business scenarios and data requirements. The most common types of key performance indicators are:

#1 - Net Profit Margin (NPM)

Net Profit Margin shows how well a company does in revenue and profit during a specific period, excluding expenses, interest payments, and taxes.

NPM = (Net Profit / Total Revenue) x 100

#2 - Customer Retention Rate (CRR)

It reflects the number of customers that a business can retain by measuring consumer spending, satisfaction, loyalty, and marketing and sales costs.

CRR = ((E - N) / S) x 100

Where,

• S = the number of customers at the beginning of the period
• E = the number of customers at the end of the period
• N = the number of the new customer within the period

#3 - Human Capital Value Added (HCVA) 

It measures the degree to which employees add value to the business, thus indicating their contribution to the business profit.

HCVA = (Revenue - (Total Costs - Employment Cost)) / FTE

Where:

• Total Costs = Revenue - Profit before taxes
• Employment Costs = Pay + Benefits
• FTE = Average number of full-time employees

#4 - Market Growth Rate (MGR)

It indicates the rate at which the market is growing or reducing. As a result, it helps the company measure its future revenue growth potential.

Market growth rate = ((Current market size – Original market size) / (Original market size)) x 100

#5 - Return On Investment (ROI)

Return on Investment evaluates the efficiency of an investment, helping the business assess financial gains from a project.

ROI = ((Initial investment value - Final investment value) / Cost of investment) x 100

This has been a guide to key performance indicators and their meaning. Here we explain how to develop KPI along with examples, types, and measurements. You may also learn more about financing from the following articles -

• Full-Form of KPI
• KPI Dashboard in Excel
• Power BI KPI