Key Performance Indicators (#282)
/In this podcast episode, we discuss key performance indicators, or KPIs. Key points made are noted below.
Definition of a Key Performance Indicator
The standard definition of a KPI is that it’s a measurement for monitoring progress toward achieving a key goal. It has to be a major contributor to the success or failure of the business, it has to be controllable, and it has to represent the actual performance of the company. So why do I bring up KPIs on an accounting podcast? Because the controller always gets stuck with reporting it. Which isn’t right, as you’re about to find out.
Why Accounting Should Not Report Key Performance Indicators
Management frequently thinks that KPIs are just another measurement, so they tell the controller to create a KPI category in the month-end reporting package, and report them there. There are a couple of problems with doing this. The first one, and it’s big, is that KPIs are never, ever financial. When the controller lists profits as a KPI, that’s just wrong. Profits are a result of how well – or not – the company has been handling its actual KPIs. Financial results are just the outcome. Therefore, revenue is not a KPI, and the return on investment is not a KPI and nothing else in the financial statements or derived from them is a KPI.
How Key Performance Indicators Should be Used
It might be helpful to show what actually is a KPI. Let’s say that you’re running an airline. If so, a reasonable KPI is the number of planes that arrive more than 15 minutes late. Customers tend to get pissed off when their flights persistently arrive late, so they’ll look elsewhere the next time around, which means that the airline loses money if its planes arrive late. Ideally, this metric should be reported to the airline president every day – who then badgers everyone in the organization about why those flights were late. Maybe it was due to the assigned gate being occupied by another plane, or a passenger arriving late on the front end of the flight and having to wait for him, or maybe there was a maintenance problem that should have been fixed the week before. Some of these issues are outside of the airline’s control, but a lot of them can be fixed.
So let’s compare on-time arrival to the definition of a KPI. First, it’s a measurement for monitoring progress toward achieving a key goal. Check. The goal is to never have a flight arrive late. Second, it has to be a major contributor to the success or failure of the business. Check. If planes are late all the time, customers will go elsewhere. And third, it has to represent the actual performance of the company. Check. The reason for late arrivals has to do with a swarm of operational issues within the company, all of which can be improved.
Let’s try a few KPIs in other industries. Like consulting. A good KPI is the number of job offers outstanding today that have been open at least a week. Why is this a KPI? Because the lifeblood of a consulting business is having high-quality staff, and if you can’t hire any, the business will fail.
Let’s try restaurants. A good KPI is the number of chefs who have resigned in the past day. This one should be obvious. When the chef leaves, junior staff have to fill in, so the quality of the food goes down. If you don’t get a replacement chef really fast, the restaurant goes out of business.
How about any supplier? A good KPI is the number of late deliveries today to key customers. You can’t afford to be late with these customers, because they’ll stop buying from the company, and then you’ll go out of business.
As you can see, none of these KPIs have anything to do with the numbers found in the financial statements, so the controller can’t do much about them.
Frequency of Reporting
Which brings up the second problem with having the controller report KPIs – which is that they need to be reported every day, not at the end of the month. A KPI should be so critical that you have to deal with it right away, or else the business is screwed. If you can afford to wait a month to look at it, either you have a poor attitude about how to run the business, or it’s not a KPI.
So can the controller realistically be expected to report on KPIs every day? No. Instead, it needs to come from whoever is in the best position to report on it. Getting back to the airline example, that’s probably the IT department, which aggregates information about airline arrival times. In the case of the consulting department, the number of open job offers obviously comes from the human resources department. What about the restaurant? That would also be human resources, though if the business is small enough, I think the owner’s going to find out about the departure of a chef pretty fast from any number of people.
And finally, if deliveries to customers are late, this either comes from the shipping department or the IT department, depending on how the company’s information system is organized. Notice that in none of these cases does KPI information originate in the accounting department. It’s pretty rare for any business to have a KPI that has anything to do with accounting.