Key performance indicators, commonly known as KPIs, are the performance metrics businesses use to determine if their established strategies and plans are accurate in predicting success. Determining which KPIs are most in need of constant monitoring will help you evaluate the efficiency of your business’s operations and its profitability, as KPIs help identify areas to improve on.
Below, we’ll examine what key performance indicators are, how they are utilized by businesses, and how you as a business owner can determine which KPIs are best for your enterprise.
What Are KPIs?
A key performance indicator, such as gross profit or revenue, provides a way to measure a company's progress toward the goals it has established. Each KPI is geared toward a specific business activity. While KPIs can vary from industry to industry, they help managers identify opportunities or potential issues ahead. If you are selling a widget, for example, you can use KPIs to measure production efficiency, profit from sales, and how many customers discovered your business through your website or social media platforms.
As a small business owner, you will need to establish KPIs to measure various aspects of your operation, because they will provide a focus for improvement and the information needed to make wise decisions. KPIs can help you set new business targets once you distinguish your leading indicators (elements that can lead to future success) from your lagging indicators (elements that led to past successes). For example, if you run a bakery, you may discover through KPIs that the supplier you have been using for years may no longer be your best option. These indicators can track a wide range of elements, including quality, timeliness, management, behavior and performance, and use of resources.
How Do Businesses Use KPIs?
KPIs are generally categorized as financial and nonfinancial. Financial KPIs include how your company manages cash flow, revenue sources and growth, profits and losses, and overhead. Non-financial KPIs, meanwhile, are indicators in other areas that can affect financial performance, including employee attendance, the number of prospects, customer experience, website traffic, and social media engagement. Some KPIs are specific to a certain industry, such as patient wait times and medication error rates for the health care industry.
Some financial services experts advise businesses to structure their KPIs around strategic priorities such as strengthening their relationships with their stakeholders—specifically employees, customers, and suppliers. What are you providing your stakeholders and what are you receiving in return? As a result, traditional measures, such as gross profit margins, are now being replaced by non-traditional metrics like social media reviews. In addition, there is an interconnectivity that creates a successful business: If employees are happy, they tend to be more productive, which can result in customers receiving better service and, in turn, increase your sales.
Note
KPIs can only partially measure success. That is why they are called “indicators.” They should be manageable, relevant , and adaptable to the evolution of your business.
Financial KPIs To Drive Your Business Strategy
There are many different types of KPIs, but some may be of greater importance to small business owners.
Gross Profit
Even though business may be good, have you determined how much you’re actually making compared to what you are spending? Calculating your gross profit can help give you an answer. If you find that your profit is not what it should be to sustain the business, determine what you need to do to cut costs and increase your margins.
Cash Flow Forecast
To find out if your sales and margins are accurate, determine how much you earn in a select time period (preferably a full budget year), then calculate the cost of operating over the same time frame. You should see the ebbs and flows of your sales and plan purchases, make hires, etc. during the most opportune times.
Inventory Gross
How many products do you sell each month? Will what you have in inventory suffice for the upcoming holiday season? What if you have a slowdown in sales? What if your suppliers can’t provide what you need? Keep track of the value of your inventory and have a plan in place to reduce the likelihood of loss.
Funnel Analysis
There is a process by which a business converts prospects into customers. For example, someone may visit your place of business or website for a period before actually making a purchase. How efficiently does your business attract new customers, and when do potential customers choose to drop out of the process (called the funnel drop-off rate)? Figuring out when and why customers drop out of the process and addressing the issues you find could lead to more customer satisfaction and sales.
Accounts Payable Rate
Knowing whom you owe and when you have to pay them can be determined by figuring out your accounts payable rate. Knowing when invoices are due and the effects of making those payments on your business's cash flow is important. While you may be fully able to meet your obligations, being knowledgeable of your company's financial transactions through bookkeeping keeps surprises at bay.
Market Share
Your business’s market share refers to the percentage of the products or services it has sold in its respective industry. What is your market position in your industry, and who are your closest competitors? Once you’re able to answer these questions through research and analysis, create a sales forecast that includes a plan to enhance your share of the market.
Note
If you’re still not sure which KPIs work best for you, companies such as Rhythm Systems offer a free KPI guide.
Identifying Your Own Financial KPIs
When deciding which KPIs you should measure, it's important to choose indicators that are customized to your business's unique needs. Remember, KPIs can help an owner identify weaknesses or issues before they become serious, so be open to examining all areas of your operation. Here are some key steps:
- Identify strategic and operational goals.
- Answer the following questions:
- What do you want to achieve and why?
- What are the best ways to analyze if the business is progressing toward the goals set?
- What can be adjusted to increase the likelihood of meeting the goals?
- Who will be responsible for the various areas of operations?
- How will you know when the business is succeeding in the areas you are analyzing?
- How often—weekly, monthly, yearly—will you review progress and make needed adjustments?
3. Get input from staff and stakeholders if applicable.
KPIs can take many forms, such as employee satisfaction, the cost of acquiring customers, the number of referrals, and time of service delivery. To avoid being overwhelmed, focus on establishing eight to 12 based on your business model and goals.
Finally, once you have established your business’s KPIs, make sure to share them with your staff or stakeholders. Employees should be made aware and fully participate in collecting the information needed to measure performance so that everyone in the organization is working in unison toward common goals.
Frequently Asked Questions (FAQs)
What KPIs are most important?
Some KPIs that can be pivotal to your business include:
- Gross profit: This is the money earned after subtracting the cost of making and selling a product, or the costs associated with providing a service.
- Revenue growth: By examining how sales develop over a selected period of time, businesses can become aware of trends in their industries. Identifying the root cause of any fluctuations can be valuable information.
- Client retention rate: If you’re primarily focused on attracting new customers, you may be neglecting the benefits of retaining existing ones. Research has shown that it is less expensive to maintain your current customers than it is to attract new ones. Satisfied customers also purchase more and refer friends and family members to the businesses they love.
How do you track KPIs?
Before you start tracking KPIs, first set your goals, define your KPIs, and set KPI targets. To start actually tracking KPIs, your accountant or bookkeeper (or you) can set up simple spreadsheets through Excel or Google Sheets, or utilize dashboard software such as Tableau or Grow, which can provide simple metric tracking to more advanced third-party integration and KPI reports.
