KPIs measure a business's performance, to help you identify points of needed improvement in your operations. Those critical gauges are also the fundamental tools for strategic planning. KPIs are the direct evidence of your business's financial health, the strength of its position in undertaking growth initiatives, its salability, its investment value, its appeal to lenders – everything you need to execute on strategic plans to reach your goals.
But, there are dizzying numbers of departmental KPIs to be tracked, including marketing, sales, operations, accounts payable, accounts receivable, production, customer services, financial management and others. With so many key indicators, which ones are really key, when it comes to big-picture strategic planning for the future of the organization?
The first course of action, is to implement any needed remedial actions the KPIs have led you to identify in policies, systems, revenue channels, production and quality processes, service protocols, etc., that threaten to adversely impact the viability of your strategic plans. Track and evaluate progress of corrective actions well ahead of undertaking your strategic planning, to give your adjustments time to improve your KPIs before you plug them into your planning calculations.
Revenues, Expenses, Gross and Net Profits are obvious top-priority KPIs and are presumed here to be understood and in use as planning fundamentals. So, here are other essential KPIs that should also be carefully tracked, analyzed, and applied to your strategic planning process:
1. Working Capital
This is cash that is readily accessible. It includes short-term investments, Cash on Hand and Receivables as well as Accounts Payable, loans and expenses accrued. This number indicates the financial position of your business, as reflected by its current ability to meet short-term financial obligations with available funds for operating.
A poor amount of Working Capital can indicate need for adjustments to resolve issues in any one of the above mentioned financial areas, for example, a problem of over-leveraging, as may be reflected in a high total amount of loan payments.
To Calculate: Subtract the business's existing financial liabilities from its current assets.
2. Current Ratio
The Current Ratio is the ratio of your business's financial assets to its liabilities. This KPI reveals the extent to which the business can consistently cover its financial commitments, on schedule, and sustain the level of credit standing necessary to obtain funding to pursue strategic growth initiatives.
The kinds of adjustments that can be made in light of this KPI, to help ensure success of growth strategies can include reducing the total amount of financial liability to bring it within a ratio that is more acceptable to lenders and more attractive to prospective investors.
To Calculate: Divide the business's total assets by its total liabilities.
3. Debt to Equity Ratio
This is the measurement of your business's profitability. This ratio indicates your success in managing the funding of your business growth by using your shareholders' investments. The number reveals the amount of debt that has accrued in your effort to build a profitable enterprise. An excessive debt ratio indicates a dependence on accumulating debt in order to fund growth.
To bring debt to equity into more appropriate alignment with shareholder expectations and lenders' criteria, focus on stronger financial accountability. For example, you might decide to temporarily freeze borrowing as your means of acquisition, as needed, during subsequent financial accounting periods, until the debt ratio is brought in line.
To Calculate: Divide the business's total liabilities by the total of its shareholder equity (net worth).
4. Operating Cash Flow
This number reflects your business's basic ability to pay for day-to-day expenses, such as materials and supplies deliveries. It indicates performance in generating enough cash to cover capital investments to grow the business. In making decisions about new capital investment, as part of your growth strategy, carefully consider the percentage of your total employed capital that is operating cash. Understanding the implications of that ratio provides additional insight into the financial strength of your business.
To find adjustments that you can make to affect Operating Cash Flow in ways that improve it as an indicator that supports your growth plans, look to budget modifications and tightening controls on operating expenditures.
To Calculate: Find the total operating income, not including depreciation, after subtracting taxes. OCF must also be adjusted for any changes to the amount of working capital.
5. Customer Acquisition Cost to Lifetime Value
The CAC is the total of marketing and sales costs involved in acquiring a customer. This KPI gauges the efficiency of your business's sales and marketing processes. It measures your business's commercial investment value. The LTV is the amount of value your customers are individually bringing to your business, on average, over the total period of time that they continue doing business with your company. A LTV/CAC ratio of 2 indicates that your business is profiting 100% on its total sales and marketing investment. So, a 2 or 3 ratio is considered a good indicator of likely long-term profitability.
Adjustments to pricing, customer services, quality processes, and many other areas of sales pipeline and operations management can be made to positively affect this critical ratio.
To Calculate: Divide the total cost of sales and marketing for an accounting period, by the total number of customers acquired by the company in that period.
6. Inventory Turnover
This KPI shows the average amount of inventory your business sold in an accounting period. It quantifies the amount of inventory turnover that is happening as the inventory continuously moves in and out again from production areas and warehouses. This indicator quantifies your business's success in selling orders that actually result in movement of inventory and in the efficiency rates of your system of production.
To make adjustments that can help ensure success of strategic growth plans based on this KPI, look at root causes of sales order cancellation rates, order processing issues, bottlenecks in production workflows, and potential issues in warehouse organizational systems, materials ordering processes, backlog management, and other processes.
To Calculate: Divide the total sales for an accounting period by the average amount of inventory in that period.
7. Return on Equity
ROE shows the amount of the business's wealth, in contrast to the net income it is generating for shareholders. The ROE reveals whether the net income for the business is sufficient for the size of the total investment shareholders have put into the enterprise.
Current net income is the primary determinate of the business's likely worth in the long-term. The ROE ratio is the indicator of the business's profitability as well as the measure of your general business management efficiency. Showing improvement in the ratio demonstrates to shareholders that management is effective in work toward maximizing their returns.
To increase ROE, adjustments that can be made include pricing changes, adding revenue channels, eliminating channels generating low margins, cutting spending, increasing training, refinancing, and any number of changes that might be indicated by careful analyses across the entire range of KPIs.
To Calculate: Divide the business's net income by the total of shareholders' equity in the company.
Other Key Performance Indicators
Other KPIs useful in strategic planning are more department-specific, for examples:
- Recurring Revenue Metrics — This KPI measures income generators that are reliable to repeat in the next period, without adding much, if any cost.
- Revenue Exit Rate — This KPI indicates revenue that is predicted to continue recurring over the coming year (not including projections for new sales). This metric is used in valuation of businesses.
- Customer Acquisition to Lifetime Value — This is the ratio of your Customer Acquisition Cost to the Lifetime Value of a customer in your business.
- Accounts Receivable Turnover — This KPI reflects the rate of customer payment collections. It is the total sales for a given period, divided by average accounts receivable for the same period.
- Customer Satisfaction — This is the indicator of your business's long-term sustainability. It measures the rate of customer retention that can be reasonably anticipated. The Net Promoter Score (NPS) is often used to calculate for this KPI.