What is a KPI
“What gets measured gets managed.” – Peter Drucker
This quote has almost lost its essence and has become a cliché. But just because something has become cliché doesn’t mean it doesn’t hold true any longer.
Imagine you embark on a new routine of running each day, you may begin to seek ways to measure your progress and track the effectiveness of your efforts.
Questions may arise regarding
- The duration of time since you started running
- The consistency of your routine
- The distance covered
- Your speed
- The impact of running on your overall health
These questions can be addressed through the use of Key Performance Indicators (KPIs), which involve the identification and use of specific numeric measures to assess and track your running performance.
In simple words, Key performance indicators (KPIs) are measurable metrics used to track performance towards specific objectives over time. KPIs are important to set targets, monitor progress, and gain insights for better decision-making throughout the organization. From Banking to Human Resources and Marketing to Sales, KPIs provide a strategic framework for driving progress and achieving goals.
What is a good KPI?
Unlike running, the business world is complex and uncertain, with various departments operating together towards a common goal. However, conflicting short-term goals may arise within different functions of the organization. For instance, the sales department in an insurance company may aim to sell as many policies as possible, while the underwriting department may not approve all these sales since they must assess the risk associated with each insurance policy.
To clarify further, KPIs or Key Performance Indicators are essential in measuring an organization’s success in achieving its goals. To ensure that these KPIs are effective, it is important to establish them at both the organizational and departmental levels. The management should consider specific guidelines before setting the KPIs, and the business intelligence department of the IT team should be responsible for calculating and reporting on these KPIs. Additionally, it is crucial to set clear and achievable targets for the important KPIs on an annual and monthly basis to monitor progress and make necessary adjustments.
Some of the best practices for defining good KPIs are as follows:
- A KPI should be easy to calculate, explain and communicate
- A KPI should have one and only one calculation logic across the entire organization
- A KPI should be time-bound and the frequency of measuring a KPI should be defined as daily, weekly, monthly, and annual
- A KPI should be aligned with the overall strategy and tactics of an organization
- A few sets of KPIs together should show a whole picture of the story, and not just a single side of it
- Keeping two opposing KPIs together reduces the risk of improving one KPI at cost of another by managers
- A KPI should be defined in such a way that it does not fluctuate a lot from a central value
- More than one KPI might be needed to measure a single aspect like profit value, and profit % of revenue
- KPIs should be as per industry standards and acceptable by market analysts, like ROTA for a finance company
- The frequency of measuring KPI should be standard, like daily, weekly, monthly, and annual
- For KPIs that are measured at a point of time like inventory, the clock time of measuring should be defined, usually, it is mid-night after day closing
- It should be made clear what will be included and what will be excluded while calculating a KPI
- There should not be any manual changes made after a KPI is calculated and reported
- If a KPI needs to be updated, the underlying data in the system should be changed, not the KPI in the presentation
Types of KPIs
Strategic KPI
This KPI evaluates an organization’s strategy and is regularly reviewed during monthly and quarterly meetings. It is designed to be in line with the overall strategy of the organization and helps to monitor progress toward achieving its goals.
- Return on Total Assets
- Profit Margin
- Average Working Capital
Operational KPI
These KPIs are aimed at measuring the efficiency of a specific process or operation within a business and are reviewed daily. They help to identify any issues that may arise and allow for quick corrective action to be taken to improve performance.
- Product Rejection % (Quality)
- Average Fly-ash Mix in Cement (Production)
- Average Duration of Call (Customer Service
Additive KPI
These KPIs are computed by adding a specific value and are designed to be easily calculated and communicated. They provide a clear and concise measure of performance that can be easily understood by stakeholders across the organization.
- Sales Quantity
- Absolute Profit Value
- Revenue
Ratio KPI
These KPIs are derived by dividing one numerical value by another. This calculation method provides a clear and concise way of measuring performance and is often used to evaluate efficiency and productivity in various areas of the business.
- Price per Unit (Value/Volume)
- Profit Margin (Profit/Revenue)
- Inventory in Days (Inventory/Average Sales)
Point of Time KPI
These KPIs provide a snapshot of a specific metric at a given point in time. They help to evaluate the current status of a particular aspect of the business and can be used to make informed decisions or take timely corrective action.
- Warehouse Inventory
- Account Balance
- Total Outstanding Amount
Period of Time KPI
These KPIs are computed by aggregating data over an extended period of time. This calculation method provides a broader perspective on performance trends and helps to identify patterns or areas that require attention. These KPIs are often used to evaluate the overall success of a business strategy or goal.
- Sales Quantity in A Month
- Monthly Average Account Balance
- Net Promoter Score
Change Over Time KPI
These KPIs are based on the comparison of a specific KPI at two distinct periods, resulting in the calculation of either growth rate or delta over time. This evaluation technique allows for the assessment of changes in performance over a period and can provide valuable insights into the effectiveness of business strategies and initiatives.
- Sales Growth for the Month
- Change in Inventory over a day
- Increase in Customer Service Level
Index Numbers
Composite KPIs are obtained by combining multiple other KPIs with different weights assigned to each, making them difficult to calculate and communicate. These KPIs are often complex, involving numerous data points and complex mathematical formulas to calculate.
- Human Development Index or HDI
- Quality Index
- Production Efficiency Index