We have examined several business principles and if you have managed to address and apply all the issues and recommendations in those previous articles, congratulations. You have a head start on most other business owners and have set the foundations for the growth of your business.
Unfortunately, there’s no time to sit back and rest on your laurels. “What now?” you say. To give you a clue, a more correct title for this article might be “Continual Performance Management”.
We have emphasised that your business operates in a constantly changing environment. To survive, you must rely on more than the basic fi nancial information presented in your accounting system.
A well constructed performance management system draws on financial and non-financial information to ensure the longevity of your business and to always strive for improvements. Performance management is the process of continually measuring areas of your business that are critical to improvements and success.
Key Performance Indicators (KPIs) form the basis of performance management. They are any measure that can impact on the profitability of your business. Financial KPIs should be balanced with non-fi nancial KPIs to give the most meaningful information to you in your capacity as manager of your business.
Financial KPIs Your annual financial statements and internal accounting records should provide the basic data to compile financial KPIs. As part of your year-end accounting service, your accountant will be able to provide and explain the various financial KPIs.
However, as your business grows, an annual review will not be timely enough. Monthly or bi-monthly reports will become necessary for you to react to shortterm changes in your business. As a business manager, you should at least have a basic understanding of financial KPIs.
That way, you can take ownership of the way your business is being run, and really make your financial advisers work by asking difficult questions. There are numerous ratios and KPIs, and the business manager should avoid becoming too bogged down in calculating dozens of ratios.
What is more important is to regularly analyse a set of ratios, comparing current performance with budgets and historical results. This will allow you to note the development of trends and to take remedial action where it is necessary before it becomes too late.
Also, measuring the business’ performance against benchmarks set by similar businesses can provide some very useful management information. Any business textbook can provide the variety of ratios which are available, but it is important that you measure the liquidity of the business, its profitability and productivity and the return on equity (ROE) it is providing to you.
Return on Equity
This indicates the return the owners are receiving from the capital they have invested in a business, expressed as a percentage. You can compare your ROE to the interest rate you would have earned had you simply put your capital into a bank deposit.
Ratios such as current ratio, number of days sales in stock, average collection period of debtors and number of times profit covers interest are just a few of the useful KPIs you should be considering regularly.
Another important KPI to measure is the business growth rate. An important point to note — a faster growth rate does not mean you are doing fine and no further analysis is required. Bigger is not necessarily better — it may indicate that you need to revise your cash fl ow forecasts to determine if more operating capital will be necessary to fund the rapid expansion. Whatever analysis you choose, the ratios must be recorded at regular intervals to provide trends.
An analysis of trends does not require you to be a financial whiz kid, but does enable you to point out movements in ratios and ask your advisers why things have changed. Non-financial KPIs The performance management of your organisation cannot be based solely upon financial indicators.
Measurement of non-financial KPIs is more likely to lead to increases in profit through efficiency or cost improvements. Although not measured in dollars and cents, these indicators have a direct impact on your bottom line.
Applying non-financial KPIs could be as simple as looking at the quantity of waste produced each month, the number of defective items produced, customer defection rates, production system outages, vehicle breakdowns and stock shortages.
These are just a few statistics which will help you to run a more efficient business. Effective KPIs are:
• Objective and measurable, • Financial and non-financial,
• Agreed upon by management and staff,
• Able to be compared or to be benchmarked against other organisations,
• Reported with other monthly reports.
The KPIs should drive staff remuneration and performance measurement. KPIs are a useful tool for continual performance management. This article has outlined a basic illustration of the application of KPIs to your organisation and how you might go about using them.
You will be aware of the benefits of KPIs and the assistance they provide in monitoring and improving your organisation. Discuss with your financial adviser how these tools apply to your organisation.
Merely by raising the issues addressed here, you are bound to come across some key success factors that your organisation can apply and benefit from.