One of the definitions we have provided in this series was the definition of a Key Performance Indicator (KPI). Per author David Parmenter in his book “Key Performance Indicators”, A characteristic of a KPI is “non-financial in nature that can be measured daily yet can have a significant impact on operations”. For my financial colleagues, that can be a head scratcher as we are always thinking of P&L and Balance Sheet items for metrics which tend to be lagging KPs. Financial statements are merely the scorecard for the results of the KPIs. So what measures of performance can we use as leading indicators of potential issues? This blog will provide some examples.
Leading Indicators tend to communicate change in the environment. They try to be predictive in nature. The Investopedia definition for lagging indicators is they “confirm long-term trends”. So let’s review what some of the top companies use for leading and lagging indicators.
The Advanced Performance Institute conducted an international survey in 2012 of 3,083 top tier companies and found that financial performance was the top measured aspect of a business along with Operations and Customer related data.
Yet, when you look deeper at what specifically companies are using for leading indicators, here is a sample that was provided by Best Practices LLC 1999 survey in CFO Magazine. Though dated, I am sure many of these are still in use.
Lagging indicators used by these public companies represented the classic financial KPIs that our clients would expect including:
In September 2014, the Journal of Accountancy (JOA) published a story on leading non-financial indicators from top social media companies such as Facebook, Linked-In, Twitter, Groupon, Pandora and Yelp. Entitled “Socially Awkward”, the article described some of the challenges SEC regulated companies have in using non-financial metrics in their SEC filings. Some of the leading indicators included:
In the above examples, the companies were trying to make a correlation between the non-financial metric and the financial metric such as operating profit. As shown in the scatter chart provided by JOA on the left, Facebook is plotting Users to Operating Profit. As noted in JOA, “While social media companies may view nonfinancial metrics as performance indicators, there does not appear to be a connection between such metrics and profitability”. Yet, the SEC (Security Exchange Commission) stated that “companies should identify and discuss KPIs, that their management use to manage the business and that would be material to investors.” “Facebook reported 1.3 billion monthly ‘active users’ and market cap grew 154% from the quarter ended March 31, 2013,” so clearly investors are also looking at non-financial metrics as well.
Morgan Stanley has a Recession Risk Model used to help predict the possibility of a recession. They identified 10 leading indicators. They include the average weekly hours of manufacturing production workers, manufacturers’ new orders, average weekly new unemployment claims, and new private housing building permits to name a few. All data points that if reviewed in summary, have the possibility of providing insights into emerging trends.
At CellarStone, we use the analytics tools to track our non-financial leading indicators. As a software company, we use many of the same metrics that Facebook and Twitter use. We look at items such as # of visitors to our web sites, the average # of pages per visit, # of emails we sent, Google clicks, # of media assets (whitepapers, videos, PDFs) downloads etc. Here is an example from one of our charts.
The goal is to use these leading metrics to help analyze expected operational and financial results. Some metrics over time will show little relevance but at least you can track to see if that changes.
As writer Tad Leahy commented in February 1999 CFO Magazine and stays true today, “ideally, the performance measurements you choose will mirror your strategic plans. But it’s hard to imagine any company that wouldn’t benefit from knowing more about the abilities of its own people. And now there’s a supermarket of non-financial metrics available to help you do that.”
So whether you use a chalk board or a dashboard tool, it is important to look at these leading indicators. The benefits include:
- Linking operational goals and trends with financial performance
- Better decision making
- Ability to anticipate changes in business conditions
All KPIs need to be viewed in aggregate and do eliminate the traditional financial ratio analysis. Rather KPIs are meant to provide a compliment of leading and lagging indicators that effectively communicate the day to day operations of the business.
Free resources available include the following:
- Free KPI Assessment Form
- webKPI List of Top 100 KPIs
- Bernard Marr’s The 75 KPIs Every Manager Needs To Know
- KPI Library