Small Business

Leading vs. Lagging KPIs – What Successful Companies Measure

Written by Steve Peterson

imageOne 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.

What Companies MeasureThe 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.

Leading Indicators

Lagging indicators used by these public companies represented the classic financial KPIs that our clients would expect including:

Lagging Indicators

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:

image

Facebook plotting Users to Operating ProfitIn 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.

Technology SupportThe Advanced Performance Institute Survey further noted that 61% of 3,083 respondents primarily used office tools such as Excel and PowerPoint to report and analyze their performance.

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.

webKPI chart

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.

KPI Resources

Free resources available include the following:


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About the author

Steve Peterson

Steve Peterson is Vice President of Marketing and Channel for CellarStone Inc. and was the cofounder of Business Intelligence Provider www.webKPI.com. CellarStone is a SaaS provider of sales commission management solutions (Easy-Commissions and @QCommissions). Steve has also been a guest speaker at UC Berkeley and has spoken at various industry groups on KPIs. In addition, he has been a CFO and senior financial manager for numerous private and public companies, and he is a CPA. webKPI can be followed on Twitter, Facebook, and LinkedIn.

7 Comments

  • Leading and lagging is like driving a vehicle. Where are my eyes looking? The windshield? The rear view mirror? I’m a windshield guy.

    Here are numbers I’m looking at in my strategic plans to grow revenues and profit in a small business:
    Customer Acquisition Cost
    New Customers per Month
    Average Direct Revenue per Customer
    Total monthly Customers
    Customer Attrition Rate
    Operating Costs
    Reserves/Investment
    Inventory

  • Excellent article! One note: any KPI (lagging and especially leading) need to be aligned with business strategy, otherwise they are too generic.

    For example, improving “customer satisfaction” might be the key to the success as it was in the case with Dell Computer, but it doesn’t tell a story neither about how a company can achieve higher customer satisfaction, nor about customer needs.

    It’s all about well crafted strategy, not just about KPIs.

  • This is a great article Steve. I just finished reading David Parmenter’s newest release of “Key Performance Indicators” as well as his whitepaper, The New Thinking on KPIs, commissioned by IBM Analytics. Parmenter suggests that labeling KPIs as leading or lagging can be misleading. He recommends treating “measures as either past, current (yesterday’s or today’s activities — the here and now), or future (monitoring the planning and preparation for events/actions that should occur in the future). I think this is a simpler way of looking at measures. There are some great examples in Parmenter’s book which I highly recommend for anyone interested in this subject.

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