What Is A KPI?
It seems like the new golden word in accounting is KPI. But what is it and should you be using them?
KPI stands for Key Performance Indicator. KPIs are measurements used in a business to evaluate the efficiency of a department/marketing campaign/business decision. It's a number that helps you evaluate your progress towards a goal you have set.
Some industries have a set of standard KPIs. These are a good starting point, but to truly get value from KPI calculation you need to tailor them to your business. KPIs tailored to an industry are just not specific enough. I may have an ecommerce store, but if my business model is pointing my business towards a higher gross profit margin comparing some of my KPIs to industry standards is not going to give me all of the information I'm looking for.
So How Do You Determine What KPIs To Use?
Simply put you need to evaluate your business goals. One thing we deeply explore with our clients during the first few months they are with us are business goals. Where is your business now and where do you want it to be in 6 months, a year, 5 years, etc? What areas do you feel you can improve in and what areas have you recently made changes in? The list goes on, but getting an idea for what the client views as their problem spots is a good place to start. We set up KPIs to help identify changes, both good and bad, in those areas. We also set up KPIs to look broadly at all areas of the company. Often times rapid changes in KPIs or KPIs that are way off industry norms can be an indication that there is opportunity for improvement even if the client did not express that area as one they feel needs to be improved.
As you can see KPIs are varied, but we've listed a few scenarios below so you can see how we identify potential KPIs.
Basic KPIs should be utilized, things like gross margin should be calculated regardless of goals and these KPIs should be compared across various time periods to ensure they are not trending the wrong way.
Googling industry KPIs is also a good start. Take some time to evaluate the results you find for your industry. These can also point you towards what industry standard values are.
But let's get into company specific KPI examples:
John runs a small ecommerce store. When setting up the store he just adopted all payment processors he could find. He's seeing his payment processing fees are really cutting into his profits and he wants to know if he would be able to lower them by using only 1 or 2 payment processors.
John would benefit from calculating the percentage of revenue being collected from each vendor that is going towards fees and then comparing vendors. For example he could take his square fees for the month, divide by the amount of sales that square processed and multiply by 100. If he does this for all of his payment vendors he can see which payment vendor is costing him the most in terms of fee percentage. He can also compare this to the average for his business. When reducing the number of payment vendors to the ones he think are least expensive he is using he should see the total percentage of revenue that is being consumed by fees being reduced. This is a great KPI for John to track to make sure the changes he implemented had the desired result.
Susan has just hired a new SEO expert to revamp her website and has also hired a new ad manager. Most of her customers are not filling out the survey so she can determine how they hear about her. She wants to make sure her investment in her advertising is producing the best results.
Susan is implementing two new advertising strategies. She should expect an increased growth rate in sales. If her sales have been steadily increasing by 4% every month with the current advertising she is doing locally she can assume that an increase above 4% is a result of the ads and SEO management. Ad campaigns have a fairly immediate impact on sales, SEO takes awhile to implement. Her new SEO improved sight will not be ready for 30 days, it should take another two to three months to be optimized. It's safe to say that the sales increase in the first 30 days is only from the ad campaigns. The increase in the following 2 to 3 months should be mostly ad campaigns and afterwards the sales increase will be a combination of ads and SEO. Susan can look at the increase in revenue amounts over these times and the increase in net income in these time windows to see which advertising effort is generating more funds.
Katie has implemented a new management system for her company. She is trying out the new program in one location and another program at a second location. She needs to determine which is producing more efficient employees.
There's a few things for Katie to consider here. The first being the existing difference between the productivity at the two locations to begin with. If historically location A has always been more productive than location B she should not expect equal management changes to create equal productivity at each location. If location B ends up being more productive it will in fact have a higher level of success because it will have a higher increase in productivity. Katie needs to determine what measures of productivity she is going to be using. For example, she may want to look at payroll expenses for each location versus the increase in finished goods inventory. She could look at the increase in savings from payroll versus the increased cost of the new management program. There are a large number of indicators that Katie could select and they will all be based on her goals for the management change (decrease in labor costs, increase in finished goods production, increased in orders filled per day, etc).
As you can see the KPIs should be tailored to each individual business and each business goal or change. Standard KPIs may not provide enough information for your company if you are operating in a non-standard way. Start by determining what you are changing, what the cause and effect of those changes are (increased management fees versus increased inventory production), and the timing for those changes in relations to other factors that could cause your KPI to be skewed. KPIs are a tool that most large businesses use and there is certainly a reason why.