Designing Meaningful Performance Metrics

One of the roles of an organisation’s Finance department is to monitor and evaluate business performance.

Finance managers, financial analysts, management accountants and other finance professionals spend a considerable amount of time analyzing the business environment, preparing budgets, forecasting financial performance and suggesting performance improvement proposals.

Where compensation is performance related, if care is not taken, employees or managers might feel that targets set for them to achieve are unattainable and this can be de-motivating leading to tensions which hinder progress towards the achievement of goals and objectives.

Managers and employees always talk of Key Performance Indicators (KPIs) sometimes called critical success factors as drivers of organizational performance.

One has to understand that what is a key performance measure differs with organization size, sector, industry, location, and level of competition.

When designing performance metrics, be they financial or non-financial, the most important factor is having all the necessary information available to aid decision making.

It could be information about your customers; their buying and spending habits, your suppliers, the macroeconomic environment, your competitors etc.

Take for example the Return on Capital Employed (ROCE) metric. It is not just a matter of picking up a percentage figure from nowhere and confirm it as the target for the month, quarter or year.

Managers and employees need to have an idea of the industry or sector averages and the assumptions underlying those figures.

The other important factor to consider when designing performance measurement metrics is the input of other managers and departments.

Sometimes problems arise when the budget holders (Sales & Marketing, Production, and IT) feel the budget size and resources available to them are so small that they cannot achieve their targets.

For example, in order to boost sales revenue, the Sales & Marketing team might feel that they have to spend more on promotions and other related activities which the Finance team might oppose resulting in friction between both teams.

To avoid such problems compounding, the Finance team should request the input of other budget holders before finalizing any departmental or functional budgets.

This input is key to ensuring that not too many resources are allocated to a certain function than necessary or vice versa. This also promotes coordination towards the achievement of organizational goals and objectives.

In addition to the above, performance measurement metrics should be seen as measures of success and guidelines for improving performance rather than as a means for punishing those who fail to meet targets.

Performance measurement is all about identifying those key areas the organization is struggling with and identifying alternative ways to improve them.

For example, if you have targeted to achieve a 20% increase in sales in the second quarter of the year and you achieve 15% instead, pointing the finger of blame at the sales manager and his team is not going to help.

Instead, performance measurement should allow you to answer one or more of the following questions:

• Why did we miss the sales forecast by 5%?
• Have we lost our customers to new competitors?
• Do we need to improve our product offering and quality?
• Is our pricing technique competitive?
• Do we need to improve on our promotion and marketing techniques to create awareness?
• Have customers clawed back on spending because of dire economic conditions?

By asking these questions first and not instantly blaming someone, managers are bound to come up with alternative solutions that are more likely to improve performance in the next quarter or so.

Lastly, designing performance measurement metrics is not about copying those of your competitors. They should be unique, linked and applicable to your organization.