Interesting Financial KPIs (REL Consulting)

28 05 2009

I found a few KPIs on the web that were worth discussion.  These are from REL Consulting (under solutions > key metrics).  These are both great KPIs for the CFO as well as for the organization to better understand.  

Here are a couple of initial thoughts:

  • As these are really Financial KPIs, which while clearly quite important, don’t always make good operational indicators.  Financial KPIs only make up part of the overall health of the organization.  
  • These are also lagging indicators, as are most financial metrics.  By the time these have changed, chances are we have already been through some business cycle and have potentially lost value we could have identified earlier.
  • The trend here is clearly important, as a change in any of these is clearly an alarm for their business.  These might be more monitoring type of metrics (sorry Jonathan, had to throw it in here), if the trend were to change it might indicate further analysis to define specific actions.  
  • We need to make sure we are not managing to these artificially.  Take for example, Days Sales Outstanding (DSO), this is often a proxy guage for customer satisfaction.  If marketing/sales changes payment terms just to impact this number we are doing the wrong thing (potentially).
  • Perhaps the greatest strength of these KPIs are as teaching tools.  If we are saying this is what is important as an end result, then we need to be able to communicate what they mean and how each of the individual processes, programs, and initiatives impact these metrics.  Most people in the organization don’t understand the financial outcomes with exception to revenue and perhaps margin.  HR and Finance should make this part of their training regimens to improve overall financial knowledge.
  • We also need to understand how these impact strategy.  If we are a high tech company with a priority on market share, chances are a lot of these numbers are going to slip.  Perhaps the converse is more interesting, if the market wants us to focus on market share growth, we need to be careful that these are not sacrificed to an inappropriate level.

Again, I am not saying these are anything other than great measures.  Nor am I picking upon REL as I have heard very good things about them.  But as you are designing KPIs, they need to be easy to understand, linked to strategy, balanced across functionality, and more often than not leading indicators.

Best Possible Days Sales Outstanding (BPDSO)

BPDSO is the value that achieved if all customers paid exactly to the agreed upon payment terms. Typically a business will offer more than one payment term to its customers and therefore the BPDSO takes the different payment terms offered into consideration by using a weighted average based on value of sales/revenue by payment term. This measure is often called the theoretical days sales outstanding (DSO) because in reality it is almost impossible to actually achieve as there will always be customers who pay late and other external factors hindering receipt of payments to term (e.g. banking delays, post service delays, etc.).

Cash Conversion Efficiency (CCE)

CCE looks at how efficient companies are at generating free cash flow from operations, or operating cash flow from sales revenues – how much free cash flow makes the journey through the operating cost structure of a company. While CCE is a simple metric to derive using it can provide powerful insights into the overall health of an organisation’s cash-generation capabilities.

Days Inventory Outstanding (DIO)

DIO is financial and operational measure, which expresses the value of inventory in days of cost of goods sold. It represents how much inventory an organisation has tied up across its supply chain or more simply – how long it takes to convert inventory into sales. This measure can be aggregated for all inventories or broken down into days of raw material, work in progress and finished goods. This measure is normally produced monthly.

Days Payables Outstanding (DPO)

DPO is a relative measure of a business’ outstanding payment liability. DPO measures the level of outstanding payments at the end of a month expressed in terms of the number of days payments represented by the creditor balance, i.e. the number of day’s worth of payments still outstanding. The metric is useful as it gives an indicator over time of what payment terms are being accepted and complied with within a company.

Days Sales Outstanding (DSO)

DSO is a relative measure of a business’ debtor exposure. It measures the level of outstanding sales/revenue at the end of a month expressed in terms of the number of days sales/revenue represented by the balance of the accounts receivables (i.e., the number of days worth of sales/revenue still outstanding). This measure is typically represented as a monthly trend and is important as the increase in the gap between DSO and BPDSO can be an early sign of deficiencies in the credit and collections process. When determining if the DSO of a company represents good performance, it should be compared to the company’s BPDSO. BPDSO is important as a reference point against which to compare a company’s DSO performance. A DSO of 92 may initially appear to be very high, but if the company’s BPDSO is 88, then a DSO of 92 represents a good performance.

Days Working Capital (DWC)

DWC is a measure of the cash conversion cycle that gives insight about the underlying health of a business. It is a key metric because it measures the average number of days of tied up working capital in the operating cycle. If DWC is trending upwards over time then it will have a negative financial impact on overall company profit.

Forecast Accuracy (FA)

Compares the ratio of forecast error to actual sales and is expressed in percentage terms. It shows the accuracy of the sales forecast compared to actual sales within a period of time, normally a month. Forecast accuracy typically shows better results when we are predicting demand for the next weeks as opposed to the next months, or where we aggregate the measure for a group of items. The more accurate the forecast, the easier it is to manage inventory levels across the supply chain.

Return on Capital Employed (ROCE)

ROCE is a ratio that indicates the efficiency and profitability of a company’s capital investments. The measure is important as ROCE ratio should always be higher than the rate at which the company borrows, otherwise any increase in borrowing will reduce shareholders’ earnings.

Shareholder Value Add (SVA)

SVA is a value-based performance measure of a company’s worth to shareholders. The basic calculation is net operating profit after tax (NOPAT) minus the cost of capital from the issuance of debt and equity, based on the company’s weighted average cost of capital. All working capital improvements help improve SVA.





Setting Targets

23 04 2009

Setting targets for Performance Indicators should be well thought through. This should not be an exercise in looking at the historical average (unless that is specifically relevant) and then apply 10% as the desired increase. You will want to review history, but you need to understand the goal. It is also important to define the KPI clearly.

For example, let’s use the retail market’s target of sales to sales last year. Retail has traditionally looked at this on a daily basis, as well as rolled up to the week, month, quarter, and year. I have two primary concerns with this:
  • If the weather was bad, we ran a promotion, or some other contributing factor, we may not know it and are really not comparing apples to apples. Additionally, what if last year was really bad? Beating that number doesn’t do much for us. 
  • If we are reviewing this on a daily basis, we loose institutional knowledge due to the repetition. What if we miss a day? Is there any repercussion? What if we miss three days in a row? What if we miss 10 days out of 14? Were there enough days in there of good performance to hide the fact that a trend is occurring?

What would make more sense to me would be to look at this number as a rolling average, or take the total sales for the last 365 days / 365 on a daily basis. Here we can very quickly identify a positive or negative trend, as we don’t have to look at numbers that swing wildly by the day of the week. Instead of talking about  a couple of bad days, we understand that even though we had a couple of bad days, the overall trend is above the goal. We can also integrate our sales goal and show it relative to the trend line.  





The Value of Scorecarding

21 04 2009

One of my first Scorecard exercises is one of my favorites.  It taught me a great deal about the power of scorecarding.  I did what I suspect most people do.  I interviewed all the VPs and developed a long list of KPIs.  I then used an excel spreadsheet to organize the KPIs.  I put the KPIs down the rows, and theVPs across the columns.  Then to help visualize the data, I placed “red” cells where VPs were directly impacted by the KPIs and “yellow” cells where the VPs were indirectly related.  I did not intend the colors for anything other to call out attention for each of the VPs.

By choosing the “red” and “yellow” I had each of the VPs concerned that they were under performing in each of those areas.  I had to explain a number of times, the reason for the colors.  
  • The first lesson was that by associating colors with performance, I clearly had the attention and focus of the executives of this team.  It sparked a number of very strong conversations about performance.
  • The second lesson is that communication is just as important.  By doing a less than stellar job of communicating (at least from a visual sense) the information, I wasted a tremendous amount of time that should have been used for more strategic discussion.  

Scorecarding can be a very powerful tool, but it needs to be used appropriately.





Scorecard Layout

26 03 2009

As you design your scorecard, you should consider the story it tells and the goal of the process. One of my favorite starts to a project began with this opening line from the client…

“I know we are doing it wrong, just be gentle when you tell us how bad…”

In this specific case, they were trying to build a cube for slicing and dicing within the Scorecard environment.  (And in all fairness to my client he had inherited this design and was trying to figure out how to use it).  They ended up with multiple depths of scorecards along a number of different dimensions.  Analysis was very difficult as that was not the purpose of the tool.  In the end we built a cube for this and found a management report that was perfectly designed for a scorecard.  This report walked through KPIs for new customers, existing customer purchases, average deal sizes, average debt.

Often a great place to start with Scorecarding is to find an existing management report.  Now the tool can easily be integrated into the management process.