There are no shortages of KPIs (Key Performance Indicators) that business leaders can track to measure performance and identify areas requiring attention. For business leaders of high growth businesses, one of the challenges can be identifying the metrics that are most critical to monitor while the business experiences a rapid increase in sales. While rapid growth is every business owners’ goal, tracking the KPIs below will help ensure growth remains profitable and efficient.
While KPIs indicate past performance, when used effectively they provide leaders with the timely insights and the opportunity to act before a problem escalates. There is no one set of KPIs and desired results that can be applied to a growing business. As we will see, each company and sector are unique, and the assessment of the results need to be fluid and adapt to changing market conditions.
In creating a set of KPIs for a growing business, it is important to establish metrics that are inter-connected and to understand how each impacts the business’ goals and profitability.
Input Costs as Percentage of Revenue
Your Input Costs KPI measures the costs incurred to deliver a product or service. For a business experiencing a rapid increase in sales, tracking the input costs is critical to ensuring you are maintaining your profit margin, and remaining profitable despite the higher revenue. This KPI is crucial to monitor in an inflationary environment. Input costs cover all elements of the costs incurred, including:
Identifying an increase in Input Costs provides leadership with an opportunity to adapt in a number of ways to mitigate its impact. Options include:
- Raise the end-sale price for the good or service to make up for the increase in Input Costs. Restaurants that can alter their menu by the day or week are well positioned to respond to a rise in food costs. The construction company working on a fixed fee contract will have to take alternative action if materials rise in cost.
- Sourcing alternative suppliers can provide a reduction in Input Costs.
- If Input Costs from a supplier are expected to continue to rise, consider negotiating a new contract with the supplier to lock in at price level for the mid-to-long term.
- Purchase in larger quantities if a discount is possible. Then take into account the cost of carrying the inventory.
- Review production processes for inefficiencies. Growing businesses can often operate in highly inefficient manner while focussing on meeting delivery expectations of the expanding customer base.
In and inflationary environment, leaders should also test their profit margins on a forward looking basis by considering replacement cost of various inputs. For example, a home builder may have acceptable profit margins when applying historical costs of inputs, such as land, against revenue. Margins may not be maintainable when considering the replacement cost of the building lot.
Accounts Receivable / Work-in-Process Investment
It is one thing to receive the new order for your product or service. It is quite another getting paid in full. Measuring your ‘Accounts Receivable / Work-in-Process Investment’ is critical to the smooth running of the business and delivering a Return on Equity. Most notably, a failure to track and stay on top of this KPI can lead to serious cash flow problems for growing businesses that may not be able to rely on a pre-established line of credit.
Tracking how long it is taking you to deliver your product or service from initial order to completion and final invoicing is a key stat to track. While that work is in process, your capital is covering the cost of production. If your KPI report is showing that Work-in-Process is getting longer, your investment increases, as does the pressure on your cash flow. A lengthening Work-in-Process may be addressed by:
- Reviewing your processes for inefficiencies that have crept in as you’ve grown. For example, have more layers of management or approvals been introduced that may be slowing things down?
- It could be that operations are operating in a highly efficient manner and the business needs to invest in more resources to accommodate growing demand in a timely manner. A “deep dive” into reasons for increased work in process can lead to solutions such as increasing inventory of key components or increasing the roles of sub contractors.
- If a reduction in ‘Work-In-Process’ time cannot be easily achieved, a change in billing terms could help reduce the strain on cash flow and investment of capital. Could clients be asked to pay a deposit up front? Could suppliers who are seeing an increase in orders from you be asked for better payment terms?
Keeping a careful eye on the number of days invoices take to be collected is equally important. The work may be complete and delivered, but you are continuing to invest capital until the bill is paid. If your Accounts Receivable days is growing it should be addresses quickly and additional metrics should be tracked by the finance department to ensure this does not get out-of-hand. These include:
- Turnover ratio
- Average days delinquent
- Number of revised invoices
- Bad debt to sales
- Percentage of high-risk accounts
Inventory Turnover & Staff Utilization Rate
The cost of carrying your inventory is an important KPI in measuring the efficiency in your business. There is the overhead cost of carrying the inventory and the lost investment opportunity of your capital each day that money sits unused in a warehouse. Of course, managing inventory should not be done in isolation and needs to be balanced with managing work in process. Reducing inventory of key components may improve inventory turnover, but it could lead to an increase in work in process which is many times more than the reduction in inventory.
Similarly, staff members who are not fully utilized on a given day is a lost investment. Keeping track of this KPI will assist in measuring the level of efficiency you have built into your process for delivering products and services to your customers.
Return on Equity
Return on Equity (ROE) measures the company’s profitability and how efficiently those profits are being generated. For most businesses, measuring Return on Equity is the end-goal. All the other KPIs, the ones mentioned above and many others, all contribute to the goal of generating a higher return on investment than could be generated if the equity was invested somewhere else. If Return on Equity is not meeting expectations, then taking steps to address the other KPIs is required.
A number of different KPI’s could be considered to measure Return on Equity. The most common is net income divided by shareholders’ equity. Such an historical cost measurement may be too simplistic for certain businesses. For an early stage capital intensive business, EBITDA as a percentage of equity might be a meaningful measure for short term results. It may also be important to consider a fair market value adjustment to equity. For example, a balance sheet with long lived assets recorded at amortized historical costs, such as an electrical generating asset, could result in a high ROE. The ROE might be quite different if the assets were restated to current fair market values.
Using KPIs can help companies measure their performance over time. They can also be used to benchmark performance against industry standards. Each industry will have its own benchmarks and the point each company is at in their lifecycle will also influence if its KPIs are above or below those standards. Industry associations and financial advisors can all help a company assess their results versus the industry norm.
Return on Equity differs from other KPIs when it comes to benchmarking. Investors have option on where to place their capital and will be looking for a Return that, over time, exceeds those options. A Return on Equity of 15-20% is typically desired, while a return of 5% or lower would raise red flags.
Adapting Your KPIs
Keeping your KPIs in place over time is important so that results can be compared to historical performance. What may need to adapt is the goals you set for each KPI. For example, if a supply chain is stretched, it may be advantageous to carry a large inventory for a longer period. As part of the decision-making process to take on that extra cost, leadership should also address how to compensate for that deployment of capital elsewhere in their operations so that the gross profit margin is negatively impacted.
Delegating your KPI’s for Optimal Results
KPI’s can be used to communicate performance goals to your team and delegation of responsibility for certain KPI’s can often be an effective method of ensuring you have a results oriented team. This must be done with care however. Some employees might have significant influence over certain KPI’s, such as work in process investment. A broad delegation of a company wide KPI, such as Return on Investment, may not be meaningful and could be a disincentive for a team if the results of their efforts are not easily tied directly to the KPI.
Creating Your Dashboard
Many accounting packages allow users to customize a KPI dashboard. While it may be tempting to review these KPIs on a daily or weekly basis, a detailed monthly or quarterly review is recommended so that the ups and downs of daily accounting entries don’t impact your analysis. Establishing your target score for each KPI is important so that a review of results clearly indicates what areas of the business need attention.
In a growing business flush with new sales, it may be tempting to ignore KPIs. But when all eyes are on the booming sales figures, other parts of the business may be failing to keep up with the increase in demand and, ultimately, drag down your financial performance, cause cash flow issues and potentially damage your relationship with suppliers and customers. Using KPIs will keep all functions in your company focused on their objectives and how they contribute to overall success and profitability.