Key Performance Indicators (KPIs) drive performance. They help communicate management’s expectations and provide a yardstick to measure results. In many companies, the accounting department is responsible for posting results, but their perspective doesn’t fully leverage the power of KPIs.
As an example, inventory accuracy is often a key indicator where perspective can drive totally different results in the company. The measure communicates the difference between what the records (e.g., the computer system) think you have in inventory and what you actually have.
As a financial measure, the accounting department is interested in the net adjustments to inventory that might occur from cycle counts, physical inventory counts, scrap and other adjustments to inventory since they have a direct impact on profit. There will be adjustments both up (we have more than we thought) and down (we have less than we thought). The net adjustment is the total of the ups and downs representing a net number.
A wholesale distribution client retained me to help reduce their inventory in order to cut cash consumption and create more warehouse space. I asked the CEO how accurate their inventory was and he proudly told me their adjustment the prior year was only $4000, which on $3 million in inventory, is pretty accurate. However, when I dug into the details of the adjustments, I found that the ups totaled $1 million and the downs totaled $1,004,000, netting the $4000 adjustment. The problem was that his inventory was actually $2.4 million off!
From a financial perspective, it was accurate, but from a customer service and purchasing perspective, it was way off. They couldn’t trust the system and had almost no idea what they had on hand. This created all kinds of problems in reordering materials (they had too much) and filling orders (they didn’t have the right things).
Another client’s accounting department posted inventory adjustments once a year after their annual physical inventory. The problem this created was that throughout the year, they thought they were making a nice profit, only to see it entirely disappear because of the year-end adjustment.
Bringing KPIs into Focus
There are three key considerations in developing KPIs to get the right perspective for your company. First, KPIs should be tied closely to company and department strategies. The old saying, “what gets measured gets managed,” is key here, as you want to manage things that move you toward your strategic objectives. Setting 4 to 6 KPIs for each strategic area of the company and departments helps set priorities for decision-making and keeps teams focused on what’s important. A few critical measures are far better than pages of statistics.
Second, measurements need to be timely to help drive performance on a daily, weekly and monthly basis. Many of my best clients use a daily flash report to measure top priority items, including:
- Dollar value of shipments for the day
- Dollar value of sales for the day
- Current backlog
- Inventory levels
- Cash in bank
- Shipped on time
Measures should reinforce your strategy, but they may need to change over time as priorities evolve. One client found they had an issue with too much overtime. When they put that measure on the daily flash report, the problem quickly disappeared, which dropped an additional 2% of revenue to the bottom line. What they found was that the managers weren’t aware of the extent of the problem until it was measured and posted. Another client thought their shipped on time was only 60%, but when we started measuring it, we found it was only 24%, which is disastrous. After shining a light on the issue, they quickly achieved over 80%, and eventually, 98%.
Third, KPIs need to be simple and understandable. They can be numbers measured against a goal, or trends presented graphically that are measured for continuous improvement. Staff members need to know how they can personally impact the results and own their department’s success. KPIs should be reviewed at daily stand-up meetings, staff meetings and company reviews. The more top management reviews them publicly, the more the staff will buy in.
KPIs need to be both financial and non-financial in nature. To achieve that perspective, responsibility for measurement and dissemination should not rest solely in the accounting department. Every department needs to measure and review KPIs in order to drive the company’s performance and accelerate revenue, profit and cash flow.
© 2019 – Rick Pay – All Rights Reserved