What are Key Performance Indices (KPIs)?
Key performance indices are measurable values of various activities, which happen in an organization. These serve as a guide to a manager to gauge how effectively the stated objectives of the organization are being achieved. Typically KPIs are compared against specific industry-standard benchmarks. In the absence of industry standards, the company could develop standard benchmarks based on past experience and trends.
While there could be various standards or benchmarks throughout the organization to capture the performance of various activities, KPIs are actually the key measures that are critical to the company’s achievement of stated objectives. We can term them as targets or goals.
Generally, KPIs are department/ activity-specific and companywide. There are KPIs which are at low level in specific functions, for e.g., in an automobile dealership in its sales department – New: Used sales ratio, or in the Parts and Service departments, a measure called absorption rate (dealership’s total operating costs that are covered (or “absorbed”) by the Parts and Service departments. These are examples of low level KPIs.
High-level KPIs concentrate on overall business performance. Thus multiple level KPIs help the managers to determine the progress of the organization.
Several companies in that industry could be collated and an industry-standard is established. These collated KPIs thus become the benchmark for that industry and serves as guidance for determining the progress of the activity or actual performance against stated strategic objectives.
The purpose of KPIs is to help businesses evaluate their achievement or failure at realizing specific targets.
According to “On Strategy’s whitepaper on KPIs, there must be 5 or 7 KPIs to measure and track performance in a structured KPI.
- There must be a Measure.
- Every KPI must have a Target or a Benchmark to compare against actual.
- Every KPI must have a defined data source to ascertain how it’s measured and tracked.
- There must be a fixed frequency to report the KPIs- example monthly or quarterly and annual.
- Must have an Owner.
What will change the perception of management by using KPIs in performance management?
- The company will start measuring Results.
- Evaluate Performance rather than People
- Start acting based on a Plan or Objective.
- Will organize formally based on roles rather than informally on people.
- Start having proper records to track data and use for measurement of metrics.
- Assign precisely defined tasks rather than ambiguously allotting tasks.
In order to develop effective KPIs, it is important to carefully study the objectives and assign these to the person who has to deliver the objectives. Thorough knowledge of the processes and activities is essential.
KPIs need to be strategic and not something random. There must be a proper structure as discussed earlier.
The process of KPIs will be complete when:
- There is a system to review the objectives.
- Actual are compared against benchmarks.
- Objectives must be time-bound.
- The KPIs are discussed with the team that is responsible.
- Periodical adjustments to the metrics are essential as business environment is dynamic.
In the next part, we will discuss with reference to a specific industry.
Courses in CPA, CFA, CMA and FRM will educate a student with insights into KPIs, their relevance, how to compute and which metrics are important to a particular industry.