If you’ve worked in a
corporate job, you probably know all about Key Performance Indicators (KPIs).
Large companies use them all the time to measure their progress and make sure
they’re on track to hit their targets.
But many small businesses are missing a trick: A recent survey by Geckoboard found that nearly half of small and medium-sized business owners have failed to identify any KPIs. The same survey found that those businesses that do track KPIs regularly were about twice as likely to hit their targets.
So in this tutorial, you’ll learn how to apply this powerful planning tool to your small business. You’ll learn what KPIs are, the benefits of using them, different types of KPIs, and how to set effective KPIs and monitor them.
By the end, you’ll be ready to use KPI reporting to take your small business to the next level of success.
1. What Are KPIs?
Let’s start with a quick definition. Here’s how business software company Klipfolio defines KPIs:
A Key Performance Indicator is a measurable value that demonstrates how effectively a company is achieving key business objectives.
The term “measurable value” is important here. KPIs are driven by specific data, so that they provide a clear measure of your progress. Instead of just saying, “Our customers love us,” you’ll be able to say something like: “88% of customers say they would buy from us again, up from 85% last year, and 82% would recommend us to others, up from 80% last year.”
That’s much more powerful than an anecdotal judgment, and it can help you by highlighting issues and allowing you to deal with them quickly. If that customer satisfaction percentage starts heading in the wrong direction, for example, you could run extra surveys to find out exactly why people are less happy with your service.
It could be that you have a particular employee who needs better training, or a competitor who offers something you don’t, or something else. Your KPIs are like an early warning system. When you don’t hit your targets, you can think of it as a red warning light flashing in your office.
The example I gave is of a customer satisfaction KPI, but you can use KPIs in different areas of your business: you could use financial KPIs, operational KPIs, sales KPIs, and so on. We’ll look at the different types in more detail later.
It’s also worth highlighting that the Klipfolio definition uses the word “key” twice. What does “key” mean? That depends on your business. A measurement that’s important for one business may not be relevant to another. And what’s important to your own business may change over time, as you grow and start to come across different problems and opportunities.
We’ll look at choosing KPIs in more detail later, but for now, just remember that “key” is a subjective judgment, and it’s driven by what you want to focus on in your own business at any particular time.
2. The Benefits of Using KPIs in Your Small Business
So why use KPIs?
Well, the survey data I mentioned in the introduction seems pretty compelling to me. Small businesses that track KPIs regularly are twice as likely to hit their targets. Here's a more detailed look at why KPIs are so effective.
KPIs for Solo Entrepreneurs
If you’re a solo entrepreneur, you’re probably trying to juggle about a dozen different jobs at once, from accounting to product development to marketing. It can be easy to end up with a to-do list a mile long but no real clarity around which tasks are the most important in moving your business forward.
Setting and tracking KPIs can keep you on track. If you’ve set them correctly, they reflect the most important elements of your business right now. For each of the tasks on your list, you can ask yourself how it will contribute to hitting one of your KPIs, and prioritise accordingly. You can make sure that you spend the bulk of your time on tasks that will have a direct impact on something that’s truly important to your business.
KPIs for Businesses With Employees
If you have employees, KPIs also serve some additional purposes. They not only help you and your employees stay focused on the right things, but also give you the ability to manage your employees more effectively.
If you employ a sales manager, for example, you can agree on some realistic sales KPIs, and then measure that person’s performance against the KPIs. It’s a more objective measure, and it’s easier to keep the person on track. Instead of saying, “I’d like to see you making more sales,” you can say, “The KPI we agreed on was to bring in 20 new customers a month, but we’ve only brought in 12 this month.”
That can lead to a much more productive discussion. Without the KPI in place, your sales manager might get defensive about your vague desire for “more sales” and claim that your expectations were unrealistic.
With the KPI, that part is taken out of the equation. The sales manager has already agreed to the target of 20 per month, and the discussion can focus on why that target has not been met. Maybe they need more support from other areas of the business, maybe the pricing is set too high, or maybe there’s a competitive disadvantage that’s putting off potential customers.
KPIs can also help your employees feel more engaged by setting clear expectations. That same Geckoboard survey found that half of British staff say their overall performance is compromised when they are not made aware of key company information and metrics.
People love to know exactly what’s expected of them, and to feel that they are making a real impact. As your business gets bigger, that can be difficult to achieve, but clear KPIs can help.
As you bring on more employees, you can even use “cascading KPIs”. For example, if you have several salespeople, you could split that overall KPI of 20 new customers per month, so that each person is responsible for 5 new sales. Their individual KPI clearly fits into an overall KPI.
The Limits of KPIs
KPIs are an important management tool, but like all tools, they also have their limitations. Having a strong focus on a particular target is great, but it can also lead to neglecting other important things that aren’t captured in the data.
If you’ve set your KPIs correctly, they should reflect the most important parts of your business, but still, data viewed in isolation can always be misleading. It’s important to keep the overall business context in mind.
Let’s return to that sales KPI example. In that case, you’re incentivizing your sales team to bring in new customers, but you’re not focusing on how valuable each customer is. Your sales team would do better by bringing in five low-value customers than by attracting a single large company that will spend huge amounts over a long period of time, even though the latter would be more valuable for your business.
You could, of course, change the KPI to focus on the lifetime value of each customer as a measure, but then there could still be problems. If your sales team focuses purely on hitting the KPI, they might end up delaying new customer signups once they’ve hit the monthly number, so that the new business contributes to the following month’s numbers instead.
So it’s important to remember, both for yourself and for your staff, that doing the right thing for your business is the main criterion for every decision. The KPIs are a means to that end, not the end in themselves. Designing your KPIs correctly will take you a long way, but still be sure to retain some flexibility, and don’t let the numbers become an unhealthy obsession.
3. The Different Types of KPIs
So what types of KPIs are there? Really, you can track anything you want to, and the areas will be different for each company, but here are some popular examples:
This group of KPIs measures the bottom line of your business: financial success. This could be revenue, net income, cash flow, the health of your balance sheet, or something more specific. For example, if debt is a problem for your business, your overall debt level could be a KPI that you want to track.
For more on the debt example, see my recent tutorial on getting out of debt, and for more examples of financial KPIs, see this tutorial on financial metrics:
These ones are about the efficiency of your business operations. How quickly do you ship orders to clients? If you have an inventory of physical products, how long do products stay in that inventory before they’re sold? There are plenty of possibilities here: for more, see my tutorial on operational metrics.
All businesses need to attract new customers. Even if you don’t want to be the next Amazon, a certain amount of growth is healthy—it helps give you more money to invest in your business and provide the best possible service. At the least, you’ll need to replace the existing customers that will depart over time for various reasons.
So you could track new customer signups, lead generation, overall revenue growth, or a range of other metrics.
As well as bringing in new customers, you need to keep the existing ones happy. This group of KPIs tracks the happiness of your existing customers—usually based on regular surveys, although you could measure it in other ways, such as the number of repeat purchases.
You could use a simple KPI like overall customer satisfaction, or you could look at more detailed metrics like the speed with which problems are resolved, levels of customer engagement with your products or apps, interactions on social media, etc.
You’ll often see KPIs defined as “leading” or “lagging” indicators. “Leading” indicators predict a particular outcome, whereas “lagging” indicators measure what’s happened in the past.
Personally, I don’t think this distinction is helpful. Measuring the future is logically impossible, so everything you measure has already happened (and so is “lagging”). But many of those past events can also be used to make predictions about the future (and so are “leading”).
So I’d recommend focusing more on the areas of your business that you’d like to track, but I mention the “leading”/”lagging” distinction so that you’re aware of it.
More KPI Categories
You can see more KPI examples in my series on business metrics, such as:
- FinancePivotal Liquidity Metrics to Help You Avoid InsolvencyAndrew Blackman
- FinanceMake Your Business More Efficient By Tracking These NumbersAndrew Blackman
- FinanceThe 4 Customer Metrics Every Business Should TrackAndrew Blackman
4. How to Set Effective KPIs
So which KPIs should you use?
First of all, here’s what not to do. Don’t start by asking yourself what data you have available. Start by identifying the most important things for your business, and then worry about how to collect the data later.
Most businesses these days have a huge amount of data available, so don’t collect everything—that can be overwhelming and distracting. Be selective, and make sure you’re collecting and tracking only what’s most important.
Choose KPIs Aligned With Your Strategic Objectives
So begin by referring back to your business plan. (You do have a business plan, don’t you? If not, see my business planning tutorial.)
Even the most informal business plan should have a clear list of strategic objectives. Begin with this list, and develop KPIs to reflect each of the areas of most importance.
British higher-education nonprofit Jisc provides a useful list of questions to ask yourself as you're setting KPIs. Here’s a condensed version of that list:
- What questions are you hoping to answer through your KPIs?
- Do these questions link directly to the strategic objectives outlined in your strategic plan?
- Are you collecting the data required to answer these questions, or focusing simply on the data you know you can easily collect?
- Are you collecting data unnecessarily?
- How and how regularly are you going to monitor progress against your KPIs?
See the article linked to above for the full list of questions (but keep in mind that some of them are more appropriate for larger institutions and may need to be customized to your small business goals).
Make the KPIs Effective
When you’ve identified the right areas to focus on, you need to choose particular KPIs to measure.
The main thing to aim for is specificity. KPIs should be sharply focused and measurable. You’re probably familiar with SMART goals, if not, or if you need a quick refresher, see this excellent tutorial by David Masters on setting goals for your small business:
Briefly, SMART goals should be:
KPIs are not exactly like SMART goals. One difference is that whereas SMART goals usually have a target date, KPIs are usually ongoing. But the framework is still helpful to ensure that you set good, specific, measurable KPIs.
Define the Parameters
For each KPI, there should be a specific minimum number that you’re aiming for. Think of my simple example of 20 new customers per month.
Some businesses also like to include some extra levels, such as a “traffic light” system. In that case, achieving the target of 20 new customers per month might be green, indicating that you’re doing well. Between 12 and 20 might be orange, indicating that you failed to hit the target, but you got close. Less than 12 might be red, indicating that you’ve got a serious problem to address.
5. How to Monitor Your KPIs
Of course, setting KPIs is a pointless activity unless you actively monitor them on a regular basis and take action as soon as you see a problem.
“How often should I track KPIs?” you may ask.
The answer is: “As often as possible.”
If you can, set up some kind of dashboard that collects all of your data in one place and is easy to update. Some accounting software offers this functionality, and there are also plenty of specific “business dashboard” software providers that will pull in data from multiple systems for you and allow you to track it in real time.
It all depends, of course, on what data you’re tracking and how much you’re willing or able to invest in software solutions. If you prefer to keep things simple, you can just pull together the data yourself into a simple spreadsheet or database. Just be sure that you, or someone in your business, make it a priority to do this frequently.
If you’re not meeting targets, it can be tempting to focus on bringing the number higher, but the most important thing is to identify the underlying cause of the problem. This may take time, but if you focus on it consistently for month after month, you should see an improvement.
Over time, you’ll probably need to refine your KPIs. You can do this as part of your regular changes to your business plan. If your strategic objectives change, your KPIs should change too.
And, although you may be tempted to change the ones you keep failing to hit, the ones that may actually need to be changed are those that you consistently achieve. If a KPI is “green” for month after month, it may indicate that this area of your business is doing fine and you don’t need to focus on it anymore. Or perhaps you can consider setting a more aggressive target.
The bottom line is that you need to track your KPIs regularly, take action when you’re not meeting targets, and refine your KPIs to ensure that they reflect progress against your company’s most important objectives.
In this tutorial, you’ve learned what KPIs are and how they can help your business. You’ve seen some examples of different types of KPIs, and you’ve learned how to set effective KPIs. Finally, you’ve learned how to monitor your KPIs regularly and how to refine them to ensure they stay relevant.
So you’re now ready to set KPIs for your own business. Use the process we’ve covered today, make sure that you’re only tracking what’s really important, and then make sure you track it as often as possible and update the KPIs whenever you need to. If you do all that, you should be well on your way to joining that minority of small businesses that successfully achieve all their targets.
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