Key Performance Indicators (KPIs): Importance and Usage

Published January 29 2020 by AlecsEPM
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Unlike my recent blog posts focused on Profitability and Cost Management (PCM) out-of-the-box capabilities, this post takes a more generic approach to explaining the importance and usage of Key Performance Indicators (KPIs). It also sets the stage for Part II which outlines the steps needed to set up and use KPIs in a Profitability and Cost Management Cloud.

By the end of this blog post, you’ll become more familiar with these concepts:

  1. KPI Fundamentals
  2. Defining meaningful KPIs

KPI Fundamentals

Key Performance Indicators (KPIs) are measurements that enable you to track and understand the performance of business components such as department, product, segment, channel or process – usually referred to as “dimensions” within an Oracle Enterprise Performance Management (EPM) application.  KPIs help monitor and drive better decisions impacting performance.  

Key Performance Indicators have the following attributes:

  • KPIs are dependent on business objectives, priorities, and available metrics
  • KPIs can be industry-specific

Various frameworks have been developed over time to help with identifying appropriate KPIs.  These frameworks suggest that a KPI should be both financial and non-financial in nature.  For example, the “Balanced Scorecard” methodology (Kaplan and Norton, 1996) suggests that performance measurements should consist of KPIs in each of four quadrants:  Financial, Customer, Internal Processes, and Learning/Growth.

Financial Performance KPIs that are common across all industries include:

 

Metric

Description

Formula

Purpose

Debt/Equity

Risk Ratio

Total Debt/Total Equity

To measure a company’s financial leverage

(use of debt to buy more assets)

ROE

Return on Equity

Net profit after tax / Equity

To measure the financial performance of a company, identifying how effectively a company is using its equity to generate profit.

ROA

Return on Assets

Net profit after tax / Assets

To measure how well a company is using its assets to general profits

Financial Performance KPIs specific to the Insurance industry include:

Metric

Description

Formula

Purpose

RPP

Revenue per Policyholder

Total Revenue/Policyholders

To measure the revenue generated per policyholder serviced. Can indicate subpar in force customer service. A higher Revenue per Policyholder indicates a strong sales strategy.

ACC

Average Cost per Claim

Total Cost of Claims Handling/Number of Claims (by type)

Used to measure the cost incurred on claims handling. Each claim can be of a different type. The distinction must be made in order to report accurate data.

LR

Loss Ratio

Total Value of Claims paid/Total Premium earned

To measure the company’s losses/ claims paid against its earned premiums. It indicates how well an insurance company is doing or if they are in financial trouble.

In Profitability and Cost Management Cloud applications, KPIs are displayed as tiles that can be grouped and combined with Analysis Views, Scatter Plots, Profit Curves, and Graphs within Dashboards. More information on how to create and use such dashboards is covered in Part II of this post.

Before understanding the steps to create a KPI, you should first focus on how to effectively and efficiently create and manage KPIs that are truly meaningful to your business.

Defining Meaningful KPIs

Before starting to build or define complex KPI formulas, you should first understand:

  1. what you are trying to achieve
  2. whether or not you have the tools in place to begin measuring

The expression “putting the cart before the horse” is often used when teams rush into implementing a visionary process (e.g. a process to track performance) without going through the analysis of finding out whether or not they can truly measure the parameters involved. Developing groundbreaking formulas without the backend to support the data feed will lead to frustration and disappointment.

Find the knowledgeable business partners that can give you the insight into whether or not the systems that you have in place can measure the performance you seek, or if the effort to lift those systems to the level you need them to perform is worth your investment. Such assessment is a mixture of not only business experience, but also of your teams’ capabilities and know-how.

Step 1: Identify Meaningful KPIs

Before starting to build or define complex KPI formulas, you should first understand what you are trying to achieve by measuring a specific performance indicator. The goal is to clearly define what the KPI will and will not measure. Choosing the most meaningful KPIs is not only a financial decision, but also a strategic decision.

Example: Does your company prioritize increased attention to client and high-quality service customization? Then measuring how quickly you get customers out the door may give the wrong impression of the type of service you are trying to provide.

Regardless of its definition or method, a KPI should always align with the goals of the company as well as enable you to take steps to correct or improve a process.

Step 2: Define KPI Granularity

Refine how you want your KPIs to be computed. This process depends not only on preference or level of detail available within the supporting software, but also on the degree of granularity that would give financial analysts enough information to support meaningful decisions.

Often, analysts are overwhelmed with detail which only fosters “analysis paralysis” and, more often than not, “busy-work,” spending precious hours validating the accuracy of data instead of drawing meaningful conclusions. If the marginal benefit of having a KPI computed in a timely manner diminishes with each hour added to its computation due to data granularity or complexity, then identifying the right balance between detail and value add takes priority. Be ready to make the difficult decisions and weigh out the pros and cons.

Step 3: Monitor Your KPIs

Remember that as business changes, so does the interpretation of what made it on the most meaningful KPI list, KPI granularity, KPI formulas, etc. Investing a lot of time and effort for marginal benefits is never a good idea.

Keep a close eye on the nature of the business. Just because some KPIs were meaningful a couple of years ago does not mean that they should still be the focus of today’s performance analysis. Allow room for transformation and growth by enabling your team to make quick shifts between meaningful KPIs. Ideally, your team should have enough flexibility to test out different options to create true “what if” analysis measurements with either new KPIs or new formulas for existing KPIs. A good reference is to look back at your business and see how it has evolved in the past 10 years. A second analysis point of view would be to check how much faster your business reality changed in more recent years. Allowing for a swift update of your KPIs and the opportunity to test out new ideas is slowly becoming the norm in high-performance organizations.

Conclusion

Performance management is tied into all business activities. Without knowing what we are trying to achieve, we are not able to accurately measure how we are performing compared to either a prior period or an external competitor. As a result, we don’t know whether we should do more of the same or completely change our approach to doing business.

In situations where there is little or no insight into the performance of a business unit, product, or company overall, the situation becomes clear when, unfortunately, it is too late to react.

Key Performance Indicators should no longer be exclusive to the finance or business analysis areas of the company. Involvement in and understanding of the true meaningful KPIs for a business should be part of everyday analysis processes. Engagement by employees increases as they become aware of how much their actions can impact the overall performance of their team, business unit, or company.

Subsequent posts to this introduction to KPIs will share how to create them in PCM applications and how to leverage them in Dashboards.

For comments, questions, or suggestions for future topics, please reach out to us at infosolutions@alithya.com.  Visit our blog regularly for new posts about Cloud updates and other Oracle Cloud Services such as Planning and Budgeting, Financial Consolidation, Account Reconciliation, and Enterprise Data Management.  Follow Alithya on social media for the latest information about EPM, ERP, and Analytics solutions to meet your business needs.

 

 

 

 

 

 

 

 

 

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