What are the methods of measuring business performance?
How can you measure the performance of the various activities carried out within it? Measuring performance, many companies underestimate the importance of knowing in detail the productivity level of their company; there are those who claim that if at the end of the year, their turnover has increased, it means that everything is fine.
If there are thousands of dollars more at the end of the budget, but in this way can you know exactly where they came from? What were the activities that produced the most? Which ones brought new customers and which ones weigh in the company coffers?
Just as it is really important to create a Business Plan in the event of a new business, so it is important to monitor the performance of your business, whether it is a start-up or a company started to optimize investments and to understand which areas to intervene on.
What are KPIs?
It is at this point that is on the scene KPI or the key performance indicators (Key Performance Indicator)
A KPI is a quantifiable measure that a company uses to determine to what extent the set operational and strategic objectives are achieved.
KPIs can also be established arbitrarily, but in order for them to be useful, they must meet the following requirements:
- Quantifiability: KPIs can be presented in the form of numbers.
- Practicality: They integrate well with current business processes.
- Directionality: They help determine if a company is improving.
- Operation: They can be related to the practical context to measure an effective change.
KPIs must be defined in such a way that factors beyond the control of a company cannot interfere with their implementation and must have predetermined time limits, which divide the analyzed process into different checkpoints.
To get a first picture of the health of your company, it is not necessary to calculate millions of indices or contact specialized professionals, just use an appropriately updated Excel sheet and analyze five fundamental indicators.
The turnover trend is the first performance indicator that must be analyzed to understand the performance of your company.
The wider the time horizon considered, the more the data will be significant to develop an objective analysis, as they are not distorted by occasional events. A growing trend in turnover is a positive sign only if accompanied by good profitability and a secure collection.
This indicator is very useful both for intertemporal comparisons, to understand if management has improved or not overtime, and for companies in the same sector and to draw interesting considerations from it.
Careful financial management is fundamental to preserve the health of the company. Margins must be transformed into liquidity, and this must be done by optimizing the management of working capital.
Efficient companies are those with a reduced working cycle, as long collection and storage times and short payment times for suppliers signify the absorption of liquidity and, consequently, the creation of financial needs.
The company's financial needs generated by current activities and investments are covered by internal and external sources of financing whose composition affects the company's health, especially in times of instability.
The higher the incidence of financial debt compared to equity, the higher the level of risk of the company as excessive indebtedness makes the company vulnerable in the event of an economic crisis, leading to bankruptcy in extreme cases.
Companies capable of producing high cash flows and attractive operating margins can also stick to higher debt levels because they still have the ability to generate income to cover interest and repay debt.
The last fundamental element to monitor the health of the company is the degree of solvency, i.e., its ability to cover financial debts through the cash flows generated by its operating activity.
Examples of KPI
There are many performance indexes that can be used, generally, in order to have a fairly detailed report of the business activity to be monitored or the general trend of the company. There is a minimum of 4 up to a dozen indices are considered. Among these we can find:
- ROE (Return on Equity): that is, how much a company actually makes to shareholders;
- CRR (Customer retention rate), that is, customer loyalty rate;
- CUR (Capacity utilization rate), or rate of utilization of production capacity
- DSCR (Debt Service Coverage Ratio) useful indicator for assessing the sustainability of the debt given by the ratio between cash flows from current operations and financial charges plus the principal portion of the debt to be repaid.
- EBITDA (Earnings before Interests Taxes Depreciation and Amortization) Measures the gross profitability of sales, i.e., the percentage of turnover that remains after the monetary costs of current operations. They have been subtracted from revenues: consumption, labor costs, and services.
These are just a few examples; of course, there are different types. It's just a matter of choosing the most suitable ones for your particular situation.
How to choose KPIs
Firms should take a number of steps before choosing the best performance indicators, including:
- having well-defined business processes;
- having defined the requirements for business processes;
- Have qualitative and quantitative measurements of the results available.
- Have determined the variants and adjusted the processes to meet the short-term objectives.
When choosing the right KPI, a company should start by examining the factors that management uses in managing the business. Then it is necessary to consider and determine whether these factors help to evaluate the progress of the company against the indicated strategies. Although industry standards are important, companies do not necessarily have to choose KPIs similar to those of their business colleagues. Instead, it is more important to find out how relevant the indicators are for the company or part of it.
What are the advantages of KPIs?
What does the use of these KPI offers in evaluating business strategies?
1. Utility and precision, they provide detailed information that you cannot retrieve from a general ledger.
2. Comparability: they lend themselves easily to comparison over time and with competitors or industry leaders.
3. Flexibility: it is possible to "build ad hoc" the most suitable indicators for the company.
- Is your company manufacturing, trading or services?
- Does your company operate in a new or mature sector?
- What stage is your business in? Is it a start-up or a company on the market for decades?
Just because your company is different from any other, it is not possible to rely on a measurement system that is the same for everyone.
Key performance indicators are important for a business because they help it focus on common goals and ensure that those goals remain aligned across the organization. This focus will help the business stay on task and work on meaningful projects that will help achieve goals faster.
Author: Vicki Lezama