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What are KPIs and why do you need them?

Written by Adrian Caruso, CEO/Master Business Coach of TA Fastrack

What are KPIs?
Key Performance Indicators, or KPIs, are statistics based on crucial aspects of a business against which other relevant statistics, or figures, can be measured.

They allow business people to make direct comparisons, thereby helping to identify a business' strengths and weaknesses.

KPIs help pinpoint strategic areas of opportunity, such as where processes or procedures could be developed, or worked on, to improve performance and profits.

Using KPIs you will be able to compare your business either against other similar businesses, or your own past performance. This is an integral part of the benchmarking process, as you need this information to make an accurate assessment of your strengths or weaknesses.

In order to make sense of your financial details, and therefore your KPIs, you will have to understand some pertinent ratios.

These ratios help you break down complicated sets of figures into easily understandable bits of information or statistics.

This is necessary, since no businesses are exactly alike and you need to find common ground in order to make valid comparisons.

Performance ratios
The following are examples of the ratios businesses can use to determine their KPIs. The ratio used will depend on the type of business you operate.

Select the indicators and ratios that apply to your particular circumstances.

Total Income Ratio
This is all sales and commission income plus any other trading income.

Calculating Cost Of Goods Sold
Opening Stock+Purchases(inc freight in)-Closing Stock x100
Total Income

Gross Profit Ratio
Total Income- Cost of Goods Sold x100
Total Income

A high Gross Profit margin reflects a good overall purchasing and pricing policy.

Calculating Overheads
Individual Overhead Item x100
Total Income

Lower results are generally better here. However, the real issue is to maximise the value from each expense item. Any payments to the owners (eg wages, superannuation, FBT, etc) have been omitted from this list - they have been treated as part of the profit figure below.

Net Profit
Gross Profit - Total Overheads x100
Total Income

A high Net Profit will normally reflect an efficient or profitable operation. It will also be influenced, however, by structural considerations such as the number of employees (whose salaries are included as part of the overhead structure) as opposed to active owners (whose salaries are included as part of "Net Profit" rather than "Salaries"). Note that owner wages have been excluded from Overheads to reflect a total Net Profit available to the owners.

Net Profit Per Working Owner
This ratio is calculated by dividing the Net Profit by the number of owners actively working in the business. Owners are expressed in terms of Full Time Equivalents (see Personnel for the definition of the term).

Personnel ratios

Personnel
Personnel are calculated in terms of Full Time Equivalents (FTEs). This means that if an employee or owner works in the business, say 2 days per 5-day week, this person has a FTE of 0.4. Similarly if a full time position started half way through the year, the person in it would have an FTE of 0.5.

Hours Worked Per Owner Per Year
This is the total hours worked in the business by all owners within the financial year, divided by the number of working owners (in FTEs).

Owners' Equity
Total Assets - Total Liabilities x100
Total Assets

This is the proportion of assets which are funded by the owners. When arriving at Total Assets and Total Liabilities both here and elsewhere in the figures, loans to and from owners and related companies are excluded.

Asset Turnover
This is calculated by dividing Total Income by Total Assets. A higher result here indicates that you are earning more revenue from each dollar of assets.

Assets Per Person
These are calculated by dividing Total Assets by the total number of employees and working owners (expressed in FTEs). This figure reflects your investment in the business. Lower results are generally better, but too low a result indicates that you may be under capitalised.

Stockturn Rate
Cost of Goods Sold
Stock of Goods or Materials

The Stockturn Rate indicates the number of times stock is replaced in the year. Higher results are generally better. However, too high a result could lead to lost sales due to stock not being available.

Gross Margin Return On Inventory (GMROI)
Gross Profit x100
Value of Stock at Year End

A high result reflects a good return on funds invested in stock.

% Revenue Drops Before Losses Start (Margin Of Safety)
NetProfit x100
Gross Profit

This ratio shows the extent to which sales can fall before the business starts to incur losses. A higher result consequently reflects greater capacity to withstand a sudden fall in sales.

Sales Area As % Of Total Area
This is the sales and display area (in sq mtrs) divided by the total floor area of the premises.

Sales Floor Area (Sq Mtrs) Per Sales Person
Sales Area (sqr mtrs)
All Sales People including Working Owners

This shows the average floor area coverage by the sales personnel (including the owners) of the business. It varies with the type of service approach the business has.

Sales Per Square Metre Of Sales Area
Income from Retail Sales
Sales Area (sqr mtrs)

This shows the average revenue generated per square metre of sales area. Retail sales includes all income earned from sales, etc, but does not include commission or other miscellaneous income. Sales area is all sales and display area open to the public, and excludes storage or car park areas. A higher result is better here.

% Of Sales Made To Account Customers
This is the proportion of sales made to customers on account, as reported by the businesses. A higher figure here indicates that you probably have money tied up in unpaid debtors' balances. This is not good for your overall cash flow.

Trading Hours Per Week

As is relevant to your business.

Creating a KPI action checklist

Key Performance Indicators are vital to the benchmarking process, however, they are just figures unless you use them to benchmark and then improve your business. KPIs are the cornerstones to creating strategies and planning your company's future. This section provides some strategies which might help improve your firm's performance. The lists do not cover all objectives, or all options, but may help show you some suitable techniques.

This section provides some strategies which might help improve your firm's performance. The lists do not cover all objectives, or all options, but may help show some suitable techniques.
While reviewing this material, it may be worthwhile to consult with partners, senior staff members, your accountant or banker. These people can all make some contribution, based on their special skills and knowledge of your firm.

After considering the other views expressed, decide promptly and act immediately.

Increase the number of customers

• Effective advertising, particularly during non-sale times;
• Regular in-store displays and demonstrations;
• An accessible and convenient location;
• Exterior appearance/identification;
• Effective, hard-working sales and customer service staff;
• Referrals from existing customers.

Increase the average sales size

• Selling higher quality or enhanced features;
• Merchandising/display;
• Stock/ sales mix;
• Accessories or add-ons.

Increase repeat trade from customers

• Staff attitude and friendliness;
• Staff sales ability;
• Business image/ appearance/ housekeeping;
• Provide high quality service.

Improve your gross profit

Keeping key objectives in mind will help you get the most from the benchmarking process.

Prevent closing stock being less than it should be through factors such as:

• Shoplifting of minor items;
• Staff pilferage of minor items;
• Damage while stock is in storage or on display;
• Stock received not checked against delivery dockets or invoices;
• Damaged stock not returned.

Eliminate high cost purchases

• Too many small orders with high freight costs;
• Too many suppliers so no quantity discounts (no stock rationalisation);
• Not taking advantage of settlement discounts (where they are worthwhile);
• Not planning purchases.

Avoid depressed total sales from the level of stock sold by correcting:

• Poor pricing (inaccurate cost prices or excessive and unauthorised discounting);
• No re-pricing (on old lines/ after a promotion);
• Poor sales mix (not enough sales of higher margin lines);
• Poor merchandising and display.

Reduce and control expenses
The following is a checklist to help reduce and control expenses.

Checklist
Improve cost control

• Budget costs annually;
• Review costs against budget regularly;
• Is each expenditure item necessary?;
• Look for better or less-costly ways of operating the business.

Improve stockturn and reduce stock investment

• Set up a stock control system;
• Stocktake regularly;
• Ruthlessly eliminate dead stock;
• Can stock holdings for individual product lines be reduced?;
• Monitor monthly sales;
• Monitor monthly purchases;
• Compare with budgets and adjust for future months to avoid overstocking.

Credit control

• Reduce debtor levels
• Establish payment terms as part of the price negotiation;
• Carefully review each request for credit;
• Prepare statements on time;
• Prepare aged list of debtors monthly;
• Consistently phone or visit late payers;
• Immediately stop account when overdue;
• Take legal action early.

Each firm has its own set of objectives. Your objectives may not correspond exactly to the major goals outlined above. It may be that other objectives (such as growth, or improved lifestyle) are relevant.
Major benefits can be obtained after spending time identifying the reasons for differences between your result and relevant sets of averages.

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