Metrics Linking KPIs with Business Strategy

In most organizations, the accounting or finance group is responsible for assembling a series of reports after month-end and after the accounting close. The reports are assembled and distributed to senior managers to provide them with a clear understanding of the state of the business. An effective reporting package should include four items: an Income Statement, Variance of Actual to Plan, Production and Financial Forecast for the Balance of the Year, and a Scorecard with Key Performance Indicators (KPIs).

The first three reports in the package present economic and production information, while the last report provides metrics associated with company objectives and department-specific initiatives. As a general rule, the KPIs provide information about the organization’s success from a strategy perspective (i.e. financial, operational, and risk/compliance). The benefits of key performance indicators are that they . . .

  •  Quickly show senior management the measurable progress that has been made toward the achievement of company strategy.
  • Provide a fast way to explain variances in income statements.
  • Make it easy to link departmental contributions to strategy attainment, which aids in performance measurement and management.
  • Allow nonfinancial individuals to understand the organization’s success at achieving goals and strategies by tracking how the KPIs change over time.

Aligning KPIs with Strategy

KPIs should be part of every department’s initiatives and be closely aligned with the company’s annual business plan. When the business plan is produced, supporting strategies must be formulated, vetted, and approved among the senior managers.

At the department level, initiatives must then be developed that foster the attainment of the company’s overall business strategy. In turn, KPIs are established to measure the success of the initiatives.

Common strategies with corresponding key performance indicators include the following:

Strategies, Initiatives, and KPIs

Company Strategy Department Initiative Key Performance Indicator
Increase Employee Satisfaction CompanywideHuman ResourcesHuman Resources % Respondents Satisfied or Extremely Satisfied from Employee SurveysHeadcountEmployee Attrition
Increase Customer Satisfaction Companywide % Respondents Satisfied or Extremely Satisfied from Customer Surveys
Increase Profit Margin Sales Profit/Units Sold
Improve Credit Quality Sales Ensure Client Credit Files contain all executed documents and background checks
Reduce Seriously Delinquent Account Receivables Sales 90 Day + AR/Total AR
Execute Targeted Marketing Campaigns Marketing # of ProgramsReturn on Marketing Investment %
Contain and Control Costs Operations Personnel Expense/Units SoldNon-Personnel Expenses/Units Sold
Improve Vendor Compliance Compliance Vendor CostsVendor adherence to Service Level Agreements (SLA)

The strategies presented here are basic and need to be adjusted based on each organization’s specific business model. Also, if the product or service sold includes multiple steps, it is appropriate to include KPIs for each step; the key performance metrics can take the form of values and/or ratios.

Controllers can play a valuable role in establishing KPIs across the organization and helping management at all levels to ensure that strategies will attain the desired financial results, in support of the company’s business goals (growth and profitability).

To develop a KPI scorecard, take the following steps:

  1.  Identify a dozen or so important activities the team can accomplish that will contribute to the strategic objectives or compliance obligations of the business.
  2. Group the variables in a logical order, such as Production, Operations/fulfillment, Post-purchase Customer Care, Audit, and Compliance.
  3. Set targets and tolerance ranges.
  4. Benchmark against your top competitors and add benchmarks for each KPI on your scorecard. This will help in tracking how you are performing vs. the desired performance level.

Once established, the KPIs can be presented to senior managers during regular financial reporting for their review. The KPI report should always include an explanation of why you fell short of, or exceeded, the targeted KPIs. After a few months you will be able to see how the company is trending.

A Few Caveats

Be careful about creating KPIs that, if maximized, could cause problems in another area. As soon as you place a number on a table and publish it, the responsible individuals will do all they can to improve the value and reach the target that is set.

For example, time to complete a process has a very large impact on customer satisfaction. Intuitively, shortening the time element will have a positive impact on satisfaction, except when quality is reduced. If you are going to track time, you should also track error rates or rework required. If time declines and rework also declines or at least stays the same, then you’re on the right track.

Another issue that can occur is when financial people hide behind the metrics. When asked a question, a person responds with the metric, which is appropriate at first. However, especially with ratios, you must understand the ingredients of the ratio.

For example, if a KPI is “90 Day + AR/Total AR” and if the ratio declined (a good factor), did 90 Day Collections improve (which is what you want) or did Total AR increase (which is what you do not want)? Do not just look to the ratio without understanding the significance of the numerator and denominator that generated the metric. There is no replacement for understanding the numbers cold.

I wrote this post for the Institute of Finance Management “Controller’s Report Member Briefing.”  It was published in the June 2015 edition.

Author: Regis Quirin
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Regis Quirin is a financial executive with 23 years of corporate experience, i.e. New York Stock Exchange, JP Morgan Chase, and GMAC ResCap; and 15 years working with small and medium-sized entities, i.e. joint ventures, start-up entities, established businesses. In 2014, Regis published "Redesign to Turnaround Underperforming Small and Medium-Sized Businesses" available via Amazon.