FINANCIAL MANAGEMENT TIPS

What Business Metrics should I use?

Business Metrics and KPIs (Key Performance Indicators) are very valuable tools in driving and monitoring business performance. It's said that "what can't be measured can't be managed".

But equally, if metrics drive behaviour, guess what bad metrics drive?

We'd be happy to talk to you about what metrics and KPIs are right for you. But in the meantime just to mention a couple of basic principles:

(1) Metrics need to encourage desirable actions. For example, if you allocate overheads based on headcount, and monitor divisional profit after overheads, this will encourage automation of processes that may becheaper to do manually. In this case probably better to simply monitor "contribution" before overheads, subject to which other metrics are used.

(2) Metrics need to be used in sets. This is to counterbalance the ease with which individual metrics can be improved simply by improving the denominator. In this example example, if an additional £10,000 is written off assets, the return on capital is improved!


  Before After  
Capital 100 90 £10k written off
Profit 200 190 £10k deterioration
       
Return on capital 200% 211% 11% apparent improvement


You also need to understand how the metric operates over time. In this example a static performance is producing a rapidly improving metric and an apparent improvement in performance:


  Yr 1 Yr 2 Yr 3
Net income 200 200 200
Depreciation -100 -100 -100
Net profit 100 100 100
       
Balance Sheet dominated by:      
Asset 400 400 400
Less: depreciation -100 -200 -300
Capital employed 300 200 100
       
Return on Capital Employed 33% 50% 100%



(3) League tables need to be used with caution. They can be very motivating for people near the top, but equally demoralising and counter-productive for people near the bottom.

To take an example outside of business: Some of the school league tables are based on percentage success rates. To improve results, it's easier to stop weaker pupils sitting exams than improving their education. And would you like to be associated with one of the bottom schools? Such downsides can be avoided.

 

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