WTF is a KPI?

I was at a conference a few weeks ago and I was talking about KPIs.

I assumed that everyone in the room knew what I was blathering on about so I was somewhat surprised when the facilitator asked if anyone had any questions for me, and the first question from the audience (made up of an array of businessmen and women) was…‘What is a KPI?’!

Despite my initial reaction, and according to people cleverer than me, there is no such thing as a stupid question. So, in this article, I will attempt to explain what a KPI is and give my top tips on selecting which ones to use…

WTF is a KPI?

Or should the first question be WTF does WTF mean but this would contradict the assertion that there is no such thing as a stupid question so let’s move on.

According to Investopedia, KPIs are Key Performance Indicators which are a set of quantifiable measurements used to gauge a company’s overall long-term performance. Find out more by clicking here

I.e. It is a set of numbers that tell you how you are getting on. Imagine you are driving a car. You probably check the speedo every few seconds, the fuel gauge every hour or so, the temperature gauge once in a blue moon but you have the key info in front you to get from A to B safely. It is the same with business, you should have your vital KPIs that you might check daily such as cash balance and sales, and other ones which you will check less frequently like the monthly P&L, but regular monitoring gives you the peace of mind that that everything is going to plan, or if not, alerts you the fact that you need to take action.

Every business is different so there is no one KPI or set of KPIs that are suitable for all businesses. However, most businesses need to sell stuff to generate revenue, need to make a profit in order to justify their existence and need cash to pay staff and suppliers, the owner’s nice dividends (yey) and boring stuff like taxes (boo). As such, if you focus your KPIs on profit, sales, and cash you shouldn’t go too far wrong.

Profit

I am going to start with profit as for most businesses, the whole raison d’etre is to make a profit. I am always slightly bemused when I speak to business owners who don’t know how much profit the business made until the annual accounts are produced eight months after the year end! So, my first piece of advice is to produce monthly (or at least quarterly) management accounts so you know that a) you are making a profit and b) can make changes quickly if you aren’t!

My second suggestion is to ask yourself how much profit do you want to make this year? If you set a profit target then we can work backwards to know what the sales and overheads need to be, and then can work out what needs to be done to achieve these profits.

Sales

Do you have a daily/weekly/monthly/quarterly sales target? If not, you probably should have. Most businesses start the year with fixed overheads such as salaries, rent, utilities etc, so you should know what your sales need to be to at least cover these, and then make a tidy profit. A business without sufficient sales is like me after a 5-mile run. Deprived of oxygen and close to extinction. I would suggest a few sales KPIs along the following lines:

  • Top line daily/weekly/monthly/quarterly sales. Some businesses such as online retailers will be able to monitor sales on a daily basis but project-based businesses such as my toolmaking business might not receive a significant order for two or more months so selecting the right timeframe to measure will depend upon the characteristics of each business. You should also measure results against your targets. i.e. what is my sales target this month to make £X profit?
  • Average sale value – how much revenue do you earn from a single sale? What can you do to increase this?
  • Conversion rate – online retailers may be happy with tiny percentages of customers vising their site making a purchase. At my toolmaking business, we expect to win 10% of the projects that we quote for. Each business will be different but once you are measuring it, you can improve it.
  • Number of enquiries received. Or this could be number of website visitors, or people who enter a shop. This KPI measures how effectively your marketing activities drive potential customers into your sales funnel.

Once you are measuring all of the above you can work backwards to understand what you need to do to achieve your sales target and how you can drive sales growth. Say you need £100k per month in revenue, and the average order value is £1,000, then we need 100 orders per month to hit the target. Our conversion rate is 10% of enquiries received so to achieve 100 orders you need to receive 1,000 sales enquiries per month. You can then look at what marketing activities drives enquires to ensure you get the right number of enquiries, or you can look at ways to increase the conversion rate, or the average sales value, and before you know it business will be booming!

Cash

It has been said a million times but cash is king and businesses don’t go bust because of a lack of profits, but because of a lack of cash. A cash flow forecast is vital, even for profitably companies. I would argue that a 13 week cash flow forecast is the #1 monitoring tool for businesses. Once this is created, monitor cash receipts daily or weekly to ensure the forecast is met and you can afford to make the budgeted payments to staff or suppliers, or those dividends to the owner!

If cash is looking tight then you can work out what levers to pull to free cash up. Have you looked at aged debtors? If there is a customer who is 30 days past due, can you call them to get the cash in? Can you clear some stock to generate cash or make staged payments to creditors? Plotting different scenarios into your forecast will help you create a recovery plan.

How many KPIs should you have?

That depends! Coming back to the car analogy, how often do you check the tachometer? That’s the dial on the dashboard telling you the RPM? If like me, very rarely because whilst I know it is vital to not over rev the engine, it is unlikely that I am going to find myself in a street race that requires 9,000 RPM out of the engine. For me, the most useful dials are the speedo and the fuel gauge, and these are the ones that I monitor regularly.

It is the same for your business. I suggest limiting it to a handful of indicators that are most important for your business that are readily measurable and focus on these. It will give you peace of mind and focus your attention on where to take remedial action if necessary.

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