Interesting Financial KPIs (REL Consulting)

I found a few KPIs on the web that were worth discussion. These are from REL Consulting (under solutions > key metrics). These are both great KPIs for the CFO as well as for the organization to better understand.

Here are a couple of initial thoughts:

As these are really Financial KPIs, which while clearly quite important, don’t always make good operational indicators. Financial KPIs only make up part of the overall health of the organization.
These are also lagging indicators, as are most financial metrics. By the time these have changed, chances are we have already been through some business cycle and have potentially lost value we could have identified earlier.
The trend here is clearly important, as a change in any of these is clearly an alarm for their business. These might be more monitoring type of metrics (sorry Jonathan, had to throw it in here), if the trend were to change it might indicate further analysis to define specific actions.
We need to make sure we are not managing to these artificially. Take for example, Days Sales Outstanding (DSO), this is often a proxy guage for customer satisfaction. If marketing/sales changes payment terms just …

Here are a couple of initial thoughts:

As these are really Financial KPIs, which while clearly quite important, don’t always make good operational indicators. Financial KPIs only make up part of the overall health of the organization.
These are also lagging indicators, as are most financial metrics. By the time these have changed, chances are we have already been through some business cycle and have potentially lost value we could have identified earlier.
The trend here is clearly important, as a change in any of these is clearly an alarm for their business. These might be more monitoring type of metrics (sorry Jonathan, had to throw it in here), if the trend were to change it might indicate further analysis to define specific actions.
We need to make sure we are not managing to these artificially. Take for example, Days Sales Outstanding (DSO), this is often a proxy guage for customer satisfaction. If marketing/sales changes payment terms just to impact this number we are doing the wrong thing (potentially).
Perhaps the greatest strength of these KPIs are as teaching tools. If we are saying this is what is important as an end result, then we need to be able to communicate what they mean and how each of the individual processes, programs, and initiatives impact these metrics. Most people in the organization don’t understand the financial outcomes with exception to revenue and perhaps margin. HR and Finance should make this part of their training regimens to improve overall financial knowledge.
We also need to understand how these impact strategy. If we are a high tech company with a priority on market share, chances are a lot of these numbers are going to slip. Perhaps the converse is more interesting, if the market wants us to focus on market share growth, we need to be careful that these are not sacrificed to an inappropriate level.

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Again, I am not saying these are anything other than great measures. Nor am I picking upon REL as I have heard very good things about them. But as you are designing KPIs, they need to be easy to understand, linked to strategy, balanced across functionality, and more often than not leading indicators.

Best Possible Days Sales Outstanding (BPDSO)

BPDSO is the value that achieved if all customers paid exactly to the agreed upon payment terms. Typically a business will offer more than one payment term to its customers and therefore the BPDSO takes the different payment terms offered into consideration by using a weighted average based on value of sales/revenue by payment term. This measure is often called the theoretical days sales outstanding (DSO) because in reality it is almost impossible to actually achieve as there will always be customers who pay late and other external factors hindering receipt of payments to term (e.g. banking delays, post service delays, etc.).

Cash Conversion Efficiency (CCE)

CCE looks at how efficient companies are at generating free cash flow from operations, or operating cash flow from sales revenues – how much free cash flow makes the journey through the operating cost structure of a company. While CCE is a simple metric to derive using it can provide powerful insights into the overall health of an organisation’s cash-generation capabilities.

Days Inventory Outstanding (DIO)

DIO is financial and operational measure, which expresses the value of inventory in days of cost of goods sold. It represents how much inventory an organisation has tied up across its supply chain or more simply – how long it takes to convert inventory into sales. This measure can be aggregated for all inventories or broken down into days of raw material, work in progress and finished goods. This measure is normally produced monthly.

Days Payables Outstanding (DPO)

DPO is a relative measure of a business’ outstanding payment liability. DPO measures the level of outstanding payments at the end of a month expressed in terms of the number of days payments represented by the creditor balance, i.e. the number of day’s worth of payments still outstanding. The metric is useful as it gives an indicator over time of what payment terms are being accepted and complied with within a company.

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Days Sales Outstanding (DSO)

DSO is a relative measure of a business’ debtor exposure. It measures the level of outstanding sales/revenue at the end of a month expressed in terms of the number of days sales/revenue represented by the balance of the accounts receivables (i.e., the number of days worth of sales/revenue still outstanding). This measure is typically represented as a monthly trend and is important as the increase in the gap between DSO and BPDSO can be an early sign of deficiencies in the credit and collections process. When determining if the DSO of a company represents good performance, it should be compared to the company’s BPDSO. BPDSO is important as a reference point against which to compare a company’s DSO performance. A DSO of 92 may initially appear to be very high, but if the company’s BPDSO is 88, then a DSO of 92 represents a good performance.

Days Working Capital (DWC)

DWC is a measure of the cash conversion cycle that gives insight about the underlying health of a business. It is a key metric because it measures the average number of days of tied up working capital in the operating cycle. If DWC is trending upwards over time then it will have a negative financial impact on overall company profit.

Forecast Accuracy (FA)

Compares the ratio of forecast error to actual sales and is expressed in percentage terms. It shows the accuracy of the sales forecast compared to actual sales within a period of time, normally a month. Forecast accuracy typically shows better results when we are predicting demand for the next weeks as opposed to the next months, or where we aggregate the measure for a group of items. The more accurate the forecast, the easier it is to manage inventory levels across the supply chain.

Return on Capital Employed (ROCE)

ROCE is a ratio that indicates the efficiency and profitability of a company’s capital investments. The measure is important as ROCE ratio should always be higher than the rate at which the company borrows, otherwise any increase in borrowing will reduce shareholders’ earnings.

Shareholder Value Add (SVA)

SVA is a value-based performance measure of a company’s worth to shareholders. The basic calculation is net operating profit after tax (NOPAT) minus the cost of capital from the issuance of debt and equity, based on the company’s weighted average cost of capital. All working capital improvements help improve SVA.

Posted in Financial Performance Management, KPI, Scorecard & Dashboard