Purpose and types of key performance indicators

Key Performance Indicators (KPIs) have been discussed in one of the Association of Corporate Treasurers other courses – Sustainability – the role of private sector finance, notably under Sustainability Linked Bonds/Loans Principles and Guidelines.

Here we take a closer look at KPIs, why they are a persistent tool for business management and some strategic options open to managers when measuring ESG progress at the organisation or project level.

KPIs are used to measure an organisation’s progress towards achieving its goals. They provide a way to track performance over time and identify areas where improvement is needed.

Broadly, the objective for any KPI is to:

• Improve performance: by tracking progress and identify areas where improvement is needed.

• Make better decisions: by providing data-driven insights.

• Communicate performance: to stakeholders, investors, customers, and employees.

• Motivate employees: by providing them with a way to track their own performance and see how they are contributing to the organization’s success.

Any project under consideration must be evaluated in terms of its benefits to the organisation and likely return on capital invested. This is only possible by understanding where things are prior to the initial commitment or by picking a point in time from where to measure. There must be strategic alignment to the overarching objective. The goal setting should clarify specific measurable targets from which sensible resource allocation can be applied. Performance tracking keeps a scorecard of progress and acts as an early detection system should results deviate. Operational efficiency against expectations and competition can be tracked and accountability and responsibility recognised accordingly. Employees will better understand how they will be assessed, and corporate communication will benefit as a result.

With data clarity an organisation is able to adapt to a changing environment, manage risk more effectively and ensure all stakeholders are fully appraised as to the progress and likely result of a project.

Categories of KPI

Broadly they fall into four categories:

1. Strategic KPIs are usually the most high-level and more likely used by executives. Examples include return on investment, profit margin and total company revenue.

2. Operational KPIs are focused on a shorter time frame and used by managing staff. These measure how a company is doing month over month (or even day over day) by analysing different processes, segments, or geographical locations. For example, individual product lines.

3. Functional KPIs for specific departments within a company. For example, the finance department or marketing department. These types of KPIs may be strategic or operational but provide the greatest value to one specific set of users.

4. Leading/lagging KPIs describe the nature of the data being analysed and whether it is signalling something to come or something that has already occurred. For example two different KPIs: overtime hours worked verses quality standards and the profit margin for a product as a result of operations.

How to create a KPI report

With companies encouraged to collect more data every day, it can become overwhelming to sort through the information and determine what KPIs are most useful and impactful for decision making. As such, prior to opening a KPI dashboard or report, consider the following:

1. Discuss goals and intentions with business partners. KPIs are only as useful as the users make them. Before commencing any KPI report, understand what is to be achieved.

2. SMART KPIs. KPIs should have restrictions and be tied to SMART (specific, measurable, attainable, realistic, and time-bound) metrics. Focus on what information there is available and meeting the SMART requirements.

3. Be adaptable. Be prepared for new problems to appear and for further attention to be given to other areas. As business and customer needs change, KPIs should also adapt with certain numbers, metrics, and goals changing in line with operational evolutions.

4. Avoid overwhelming users. Less is more. At a certain point, KPIs start to become difficult to comprehend, and it may become more difficult to determine which metrics are important to focus on.

Advantages of KPIs

KPIs help inform management of specific problems; the data-driven approach provides quantifiable information useful in planning and ensuring operational excellence. KPIs are statistically supported and aim to be unequivocal. They promote accountability.

KPIs are the bridge that connect actual business operations and goals. A company may set targets, but without the ability to track progress toward those goals, there is little to no purpose in those plans. Instead, KPIs allow companies to set objectives, then monitor progress toward those objectives.

Limitations of KPIs

There may be a long time-frame required for KPIs to provide meaningful data. For example, data may need to be collected for years to better understand trends.

They require constant monitoring and close follow-up to be useful. In addition, KPIs that are not continuously monitored for accuracy and reasonableness do not encourage beneficial decision making.

They open up the possibility for managers to “game” KPIs. Instead of focusing on actually improving processes or results, the selection may be chosen for performance bonuses or be easily achieved.

Pros

• Informs management of how a company is specifically performing.

• Helps hold employees accountable for their actions (or lack of).

• Can motivate employees who feel positively challenged to meet targets.

• Allows a company to set goals and measure progress toward those objectives.

Cons

• May take a long time to generate meaningful data.

• Requires ongoing monitoring for accuracy and reasonableness.

• May encourage managers to focus on KPIs instead of broader strategies.

• May discourage employees if KPI targets are unreasonable.