An Introduction to Key Performance Indicators
Key Performance Indicators (or KPIs for short) are critical to Business Intelligence. A KPI describes your business or process performance. Do you know if you are performing better than last year? Are your sales stable? How much money do other businesses owe you? Do you owe other businesses? There are a myriad of questions that can be asked about your business or process performance. KPI’s help provide insight to answer those questions. With understanding comes better decision making and increased performance for your bottom line. As Business Intelligence experts, it is our job to help you identify and answer those key questions about your business. A Key Performance Indicator is a value that is key to your business's success and performance. There are a lot of numbers you can assign to your process. However, values that best determine your business performance and growth are your “Key” Performance Indicators.
Before we get started, we need to understand KPIs fully. At its most basic level, a KPI is a number that is associated with your business and some master data over a time period. Such as, we have 5 Invoices due next week. So, the number 5 is associated with next week and the master data is the invoice number. All three pieces of data accurately describe a situation. Another is, If we pay 2 Invoices this week, we will receive a 3% discount from our suppliers. And yet, another is, the Manufacturing Process currently yields 95% at First Pass.
I worked at a company out of college. This company took over a month to put together their monthly forecast. They would cobble together spreadsheets from 5 different departments and 20 different people. They would constantly adjust the numbers they sent in on their spreadsheets. Then they would adjust those numbers in line with the forecasting systems and finally come up with a forecast over a month later. The Forecasting Manager would then tell everyone, remember, by the time we get this forecast out, it’s obsolete. So, if we could get our forecast completed daily, that obsolescence would be a thing of the past. In this case, we had a KPI for forecasted sales numbers and amounts, but they were old. Old is better than nothing because it is something. Also, there is a KPI that you are most likely missing from the story. That KPI is the number of days it takes to create a Forecast. Now, if you have a baseline of 30+ days, you know if you drop that down to 5 days, you have accomplished a great task. What about getting it down to 1 day? That’s even better. What about less than a minute? This is when the focus of the story changes from “when will the forecast be ready” to “Why is the forecast changing?” By choosing to focus on the correct KPI’s, you make your business run more efficiently for you and your focus can change to driving business growth rather on one small aspect of your business.</span>
With the right set of KPIs, you can know your business and its health much clearer. I was working with the owner of a Spa. She mentioned business was great and they just sold the big room for $6.25/ft2. I mentioned that sounds great, but what is your break-even amount per square foot? It was like I was speaking a different language. I reiterated, what are your total costs per square foot? The owner did not know. So, I did some basic math for her. $3500 for the lease, $500 for utilities, $100 for water, plus miscellaneous office costs for a total monthly cost of about $4500/month. Then I looked at the square footage they were working with. 1500ft2 total space, well, subtract the hallways, reception area, laundry area, bathrooms, and any other area that they did not sell and we came up with 1100ft2 of saleable space. So, on the first pass evaluation, it looks like a great deal. Basic Costs were about $4.09/ft2. What we did not look at yet were labor and basic materials (towels, printer papers, toilet paper, etc…) to keep the business going. Those costs added an additional $2600/month. This drove up the basic cost of running the place to $6.45ft2. Throughout all of this discussion, I noticed that the owner never mentioned she was receiving any payment for her time at the Spa and mentioned if she wants to withdraw money and have it be part of the business model, then that should be calculated into the costs. So, we added another $2000/month for a small salary for herself. This drove the break even amount up to $8.27/ft2. So, after our discussion, the owner now knew that $6.25 was not such a great deal for the business as she had hoped. She also had a basic model to cost her new opportunity to sell room space in the spa. She also determined that she needed other sources of revenue with offset the losses in the lease agreements and eventually made up the difference. Knowledge is power and can make or break your business whether you know or do not know what is good for your business.
I have mentioned Base KPI’s. What other types of KPI’s are out there? Well, you have three main types: Base KPI’s, Compound KPI’s, and Complex KPI’s. A Base KPI is just a number attached to a process and a date(s). Our 5 Invoices for next week, or Next Week’s Invoices Total $1000, are Base KPI’s. They give you an idea of what is going on and can be however specific or detailed that you want. Base KPI’s describe the situation.
Compound KPI’s help determine your organization’s health and well being. These KPI’s group two or more Base KPI’s to help determine a situation for your company. Next week, we have 5 Invoices for $1000 that should be paid. We also have 2 Vendor Invoices that we need to pay that total $300. Our Gross Cashflow for Next week should be +$700. Cashflow depends on other KPI’s to be calculated and can allow for better decisions to be made. Let’s say the Customer and Vendor Invoice Amounts were reversed. We owe $700 instead of getting $700. We might have to make different decisions based on how much money is in the bank.
Complex KPIs can be created to determine industry or business specific values. These KPI’s have a complex calculation that can be industry specific. Take for example, the Semiconductor Industry’s Book-to-Bill Ratio. Not only is this calculation industry specific, the few Semiconductor Companies I worked for used different calculations. So, this is not a raw KPI like a Base KPI. It is calculated in a complex way and specific to each company and or Industry.
In the end, the strongest companies have knowledge of their Business, Industry, Social Media Standing and especially their Competitors. If you are not working with the correct set of KPI’s and comparing them to your competition, it is hard to understand your position in the market. If you do not understand your business the way you should, your business could be going down the wrong path. It is better to have a signpost pointing the way for you than to grope through the dark in the direction you think you should be going. This is, afterall, the age of Data. Let's use it to our advantage!