Can you imagine playing a game of golf without keeping score? Or watching a game of football without looking at the scoreboard? Sports scores are numbers that tell us a story.
On the playing field, scores give us insight into who is winning and who has the competitive advantage. Without a score, we don’t know if players are making meaningful progress toward a goal, if they’re running in circles, or if they’re barreling straight into a loss.
In the same way, why would you run a business without knowing the score? Successful entrepreneurs and executives measure their company’s progress against key performance indicators (KPIs). KPIs are carefully chosen metrics—numbers that capture an organization’s operational and economic health within the context of industry benchmarks and economic conditions. KPIs tell a story about how well your company is “scoring” in the marketplace.
When I speak to groups of entrepreneurs, I often start by asking business owners to share the key metric that drives the most value in their business. I'm often surprised by how few of them can distill their business proposition down to a few key metrics. Without those metrics, they won’t know exactly how the company is performing and cannot accurately gauge where they’re heading—or if the business is careening toward a ditch.
Important Metrics to Track
I encourage entrepreneurs to identify key metrics that sum up what really matters to their business and track them monthly. For example, a construction company might focus on backlog, future work that will put money in the bank. Backlog represents the pipeline of future accounts receivable.
A manufacturing company would track inventory turns, the rate at which materials come into the plant and go back out again. This KPI reveals if the organization has achieved just-in-time workflows. It can answer the question, which merchandise is being produced but not selling? Merchandise that doesn’t turn over becomes “stale” and incurs carrying costs. If you have a lot of inventory sitting on the shelf for too long, it’s tying up cash and risks becoming a liability.
Another metric that can be useful for manufacturers is throughput. This KPI helps answer the question, do we have to run another shift? This number confirms you’re maximizing the return from equipment and labor investments and successfully following lean practices.
Service companies, such as plumbing repair crews or systems engineering firms, might instead track employee turnover because human capital is their primary asset. They know constantly recruiting and training new people adds to labor costs and can jeopardize their ability to fulfill client contracts without disruption. A wealth management firm like Balentine might track client retention, a metric that captures the extent of client engagement and trust.
Certain KPIs are useful for virtually every type of business. For example, recurring revenue versus transactional revenue are metrics that clarify the effort required to close a sale and generate new income consistently over time. Client concentration is a metric that watches for “too many eggs in one basket.” It answers the question, is my customer base sufficiently diversified to limit risk exposure? Other common KPIs include assets, liabilities, capitalization, and profitability.
Start from the Beginning
My experience with advising entrepreneurs and business owners over the years has convinced me it is never too early to track meaningful KPIs. One entrepreneur had a consulting concept that became wildly successful almost overnight. The niche was underserved, and the market responded eagerly. One particular client began to feed the company more and more revenue. To meet the demand, they expanded staff and overhead. Dizzy from this boom cycle, the CEO never sat down and evaluated just how much of the bottom line each client represented. When that one huge contract wasn’t renewed, 80% of his business evaporated overnight.
If this entrepreneur had begun measuring client concentration as a KPI from the outset, he could have seen just how vulnerable this business was and taken steps to diversify his revenue stream sooner. Fortunately, he was ultimately able to work through difficult decisions and “right-size” his business. Despite the profound set back, his business was salvaged and emerged as a much more sustainable operation going forward.
Another business owner who failed to track the KPI of free cash flow was not so fortunate. Her business had provided vital personnel to a client’s facility, and when that facility stopped paying and ultimately went bankrupt, the entrepreneur didn’t have enough cash on hand to cover payroll. Banks were reluctant to lend her more money due to an economic downturn, and she had to scramble reactively to raise new equity capital. This led to her ownership being diluted to a point where she lost her controlling stake of the company.
Create a Simple KPI Dashboard. What Gets Measured, Gets Done!
At Balentine, we track our KPIs in a trailing 12-month chart, so we can always look back and compare results over the prior year. Each month, we add the recent month’s number at the top and drop off the oldest one. This allows us to graphically spot trends as they are happening. For example, if we see expenses are climbing in certain areas, it generates a series of questions as to why, and gives us sufficient time to make informed changes to run our business better.
If you are a business owner who dislikes tracking granular numeric details, a good solution is to hire a CFO who will create and maintain the KPI dashboard for you. The KPI dashboard can be presented in a graph format with simple color coding that highlights potential trouble spots in red, for example. To be even more effective as a tool for proactive decision making, the dashboard should also include metrics that track industry conditions and economic conditions. (To better understand where the economy is heading, keep an eye on capital markets, as I explain in this earlier blog post.)
Data do not lie, although the messages they send may be uncomfortable.
Too often, entrepreneurs allow themselves to be guided by a general gut reaction or sixth sense, without examining the hard data unemotionally. Data do not lie, although the messages they send may be uncomfortable. When you focus on key metrics, you can be confident that you know how your business is really performing. If trouble is brewing, you’ll have a real-time diagnostic tool at your fingertips. Such a data-driven approach imparts a discipline to take action to improve outcomes, even when things are seemingly going very well. What gets measured, gets done!
If that safety valve isn’t enough to persuade you of the value of KPIs, remember that tracking KPIs doesn’t just help you run your company better. This practice also helps keep you focused on what creates the most value for your business so that you will get top dollar when you decide to exit.