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What are Key Performance Indicators (KPIs)?
Among other things, key performance indicators (KPIs) can be used to assess a company's long-term performance. KPIs are particularly useful for analyzing a company's strategic, financial, and operational performance in comparison with its competitors (operating in the same sector). Among the most common KPIs are financial metrics, such as net profit, revenue less certain expenses, or the current ratio of current assets to current liabilities. The primary focus of customer-oriented KPIs is on improving customer service, increasing customer satisfaction, and retaining customers. The purpose of process-oriented KPIs is to measure and monitor the effectiveness of company operations at all levels. There are KPIs for all departments (management, finance, sales, marketing, human resources, information technology, etc.). Typically, business analytics software and reporting tools are used to evaluate and monitor KPIs.
A financial KPI may also assist a company with
setting and controlling internal targets. By utilizing financial KPIs, the controlling department can measure, control, and optimize sales, costs, profits, and cash flows. Finance-related key performance indicators are typically centered on revenues and profit margins. The most widely accepted profit-based measurement is net profit. After adjusting for all costs, taxes, and interest payments for the same period, it represents the amount of revenue remaining as profit for the period.
Examples of Financial KPIs
Net Profit Margin
In terms of profitability, the profit margin is one of the most commonly used ratios. In order to determine how much profit a company is making, the ratio indicates what percentage of sales remains as profit. Therefore, profit margin serves as an indicator of a company's financial well-being, growth potential, and, by extension, its managerial capabilities.
Liquidity Ratios
A company's liquidity ratios include, among others: Cash Ratios or Cash Liquidity (1st degree liquidity), Quick Ratios or Acid Test Ratios (2nd degree liquidity) and Current Ratios (3rd degree liquidity). These ratios indicate if a company is solvent.
Price-Earnings Ratio
Investors and analysts often use the price-earnings ratio (P/E ratio) to evaluate companies and shares because it is a simple ratio to calculate. It displays the ratio between the current share price and earnings per share (EPS). Shares can be overvalued or undervalued.
Earnings Yield
In financial terms, earnings yields are the reciprocal of price-to-earnings ratios, and they provide insight into the value of a stock. The earnings yield is calculated by dividing the earnings (last 12-month/year period) by the current market price. In other words, earnings yield represents the percentage of earnings per share of a company. The earnings yield is a useful tool for determining whether certain stocks are overvalued or undervalued.
Free Cash Flow Yield
This ratio measures the solvency of the company based on its free cash flow (FCF). This ratio examines the relationship between a company's free cash flow and its market value. FCF yield is commonly calculated by dividing free cash flow by market capitalization, which is a readily available figure. FCF returns are similar to earnings yields.
Return on Investment
Calculating return on investment is one method of determining whether an investment is efficient or profitable. Furthermore, the figure can be used to make comparisons between different investments. An ROI calculation is derived by comparing a given investment's return with its cost. To put it simply, the ratio measures the profitability of a company's capital investment.
Price-to-Sales Ratio
In its simplest form, the price-to-sales ratio compares the price of a share (a company's share price) with the company's revenue or sales. This ratio represents how the financial markets value each monetary unit of revenue generated by a corporation. Therefore, the price-to-sales ratio represents an investor's willingness to pay for one franc of sales per share.
ROE and ROA
ROE and ROA are indicators of the profitability of a company in relation to its assets. A company's Return on Equity and Return on Assets are two of the most important measures for evaluating the efficiency of its management team in managing their capital. Financial leverage (the ratio of debt to total capital) is the main difference between ROE and ROA.
Price-to-Book Ratio
The ratio provides information about a company's valuation by comparing the price of a share with its book value or equity. The price-to-book ratio of a company is often considered to be favorable if it is low. There is, however, still a possibility that a low price-to-book ratio may indicate that negative information has already been priced into the share price, which has not yet been reflected in the book value. A company's book value is calculated by dividing its equity by the number of outstanding shares.
Customer-Focused KPI Examples
In general, customer-focused KPIs are based on the efficiency per customer, customer satisfaction, and customer retention of an organization.
The Customer Lifetime Value (CLV) is the amount of money a customer will spend on products and services during the course of their business relationship with the company.
Customer Acquisition Cost (CAC) refers to the total cost of acquiring a new customer. An organization can measure the effectiveness of its customer acquisition efforts by comparing CAC and CLV.
In financial consulting, customer-related KPIs are widely used to increase employee motivation and efficiency, but they must also be viewed critically, particularly since there are often conflicting interests between customer interests and meeting KPIs, for example, in order to achieve bonus targets.
Process KPI Examples
The purpose of process metrics is to measure and monitor the operational performance of an organization.
Companies can measure the percentage of defective products by dividing the number of defective products by the total number of products produced. Obviously, a low number is preferred.
Turnaround time refers to the amount of time it takes to complete a particular task. A drive-through restaurant, for example, can measure the time it takes to serve an average customer - from the time the order is placed to the time it is picked up
Nowadays, marketing is carried out across a variety of media and platforms. The performance of this area is also measured using KPIs. For example, YouTube counts the number of video views and subscribers. On social media platforms such as Facebook, LinkedIn, and Instagram (followers), the number of subscribers is equally important. Additionally, customer demographics are analyzed in order to determine which customers are interested in the products/services. A number of KPIs are used by Google Analytics, including sessions, users, bounce rate, users by gender, pages per session, dwell time as well as vertical scroll depth in percent (25%, 50%, 75% and 100%).
Risks associated with KPIs (Financial Industry)
In the financial industry, sales targets are often used as key performance indicators. To achieve the specified goals, front-line bank or insurance employees, for example, feel compelled to sell a predefined portfolio of products. It is likely that the company will provide higher incentives as the earnings from these financial products increase. Therefore, advisors will inevitably become salespeople or have to find a new career. A good question to ask when speaking with a financial services provider is whether the conversation is primarily about providing advice or more about selling. An independent financial advisor or wealth manager without conflicts of interest can be of assistance in this situation.
KPIs also have the following disadvantages:
- It is only possible to compare KPIs from different companies within a limited range (e.g., the same industry).
- To provide meaningful data, KPIs require a minimum period of time.
- In order for KPIs to be useful, they must be monitored constantly.
- Managers may manipulate KPIs.
- A manager who pays too much attention to productivity KPIs is likely to see a quality decline (extrinsic motivation rather than intrinsic motivation).
- When supervisors specifically target KPIs, employees can be subjected to undue pressure.
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