What are key performance indicators (KPIs)?
Key performance indicators (KPIs) are calculated, for example, to evaluate the long-term overall performance of a company. In particular, KPIs help to determine the strategic, financial and operational performance of a company, especially in comparison with other companies in the same sector. KPIs can be financial in nature, such as net profit (or bottom line, gross profit margin), revenue less certain expenses, or the current ratio of current assets(liquidity and cash availability) to current liabilities. Customer-oriented KPIs generally focus on efficiency per customer, customer satisfaction and customer loyalty. Process-oriented KPIs are aimed at measuring and monitoring operational performance throughout the company. KPIs therefore exist for all functions (management, finance, sales, marketing, HR, IT, etc.). In general, companies measure and track KPIs using business analytics software and reporting tools.
A financial KPI also helps a company internally to set and monitor targets based on figures. Financial KPIs thus support the controlling department in measuring, controlling and optimizing sales, costs, profits and cash flows. Key performance indicators relating to finances usually focus on revenue and profit margins. Net profit is the most tried and true of the profit-based measures. It represents the amount of revenue that remains as profit for a given period after all of the company’s expenses, taxes and interest paymentsfor the same period have been taken into account.
Examples of financial KPIs
Nettogewinnspanne
The profit margin is one of the most widely used profitability ratios. It measures the extent to which a company is making money by indicating the percentage of turnover that remains as profit. The profit margin is therefore an indicator of the financial health of a company, its growth potential and, in a broader sense, the skills of its management.
Liquidity ratios
Analysts use the following ratios, among others, to analyze companies: The cash ratio or cash liquidity (1st degree liquidity), quick ratio or acid test ratio (2nd degree liquidity) and the current ratio (3rd degree liquidity) are also referred to as liquidity ratios, which show whether a company is solvent.
Price-earnings ratio
The price/earnings ratio (P/E ratio) is a key figure that is frequently used by investors or analysts to value a company or share, as it is characterized by its simplicity. It indicates the ratio of the current share price to earnings per share (EPS). The P/E ratio can be used to determine whether a share is overvalued or undervalued.
Return on profit
The earnings yield is the reciprocal of the price/earnings ratio and is an indicator of the value of a share. The earnings yield refers to the profit for the last 12-month period divided by the current market price per share. The earnings yield thus shows the percentage of a company’s earnings per share. Investors can use the earnings yield to determine whether certain shares are overvalued or undervalued.
Free cash flow return
The free cash flow (FCF) yield is a solvency ratio. It compares the free cash flow that a company is expected to generate with its market value. The most common method of calculating the FCF yield is to divide the free cash flow by the market capitalization, as this figure is generally available. The FCF yield is similar to the earnings yield.
Return on capital
The return on investment is used to calculate the efficiency or profitability of an investment. At the same time, the figure can be used to compare the efficiency of different investments. To calculate the ROI, the return on a particular investment is set in relation to its costs. In other words, the ratio measures the profitability of a company’s capital employed.
Price/sales ratio
The price/sales ratio (P/S ratio) compares the price of a share (a company’s share price) with the company’s income or sales. The P/S ratio is therefore another share price indicator and shows how the financial markets value each monetary unit of revenue generated by a company. In other words, the KUV indicates how much an investor is prepared to pay for one franc of turnover per share.
ROE and ROA
The return on equity (ROE) and return on assets (ROA) indicate how profitable a company is in relation to its assets. Return on equity and return on assets are two of the most important measures for assessing how efficiently a company’s management team manages the capital entrusted to it. The main differentiator between ROE and ROA is financial leverage (the proportion of debt in total capital) or debt.
Price-to-book ratio
The price-to-book ratio puts the price of a share in relation to the book value or equity of the share and provides information on the valuation of a company. If the price-to-book ratio is low, the company is often valued favorably. However, a low price-to-book ratio could also mean that negative information is already priced into the share price which is not yet included in the book value. The book value per share is measured by dividing equity by the number of securities in the company.
Examples of customer-related KPIs
Customer-oriented KPIs generally focus on efficiency per customer, customer satisfaction and customer loyalty.
The Customer Lifetime Value (CLV) indicates the total amount that a customer will spend on products and services during the entire business relationship.
Customer Acquisition Cost ( CAC ), on the other hand, represents the total sales and marketing costs required to acquire a new customer. By comparing CAC and CLV, companies can measure the effectiveness of their customer acquisition efforts.
Customer-related KPIs are often used at employee level to increase their incentives and efficiency, but they must also be viewed critically, especially in financial consulting, as there is often a conflict of interest between customer interests and the fulfillment of KPIs, e.g. to achieve bonus targets.
Examples of process KPIs
Process metrics are used to measure and monitor operational performance throughout the company.
For example, by dividing the number of defective products by the total number of products produced, companies can measure the percentage of defective products. Of course, the aim is to keep this figure as low as possible.
Throughput time, on the other hand, indicates the total time it takes to complete a particular process. The throughput of a drive-through restaurant, for example, can measure how long it takes to serve an average customer – from the time the order is placed until the customer collects their food.
Marketing and Internet platforms
Nowadays, all media and platforms are used for marketing. KPIs are also used in this area to measure performance. On YouTube, for example, the number of video views and the number of subscribers are counted. The number of subscribers is just as important on platforms such as Facebook, LinkedIn and Instagram (followers). Customer demographics are also analyzed here to determine who is interested in the products/services. Google Analytics uses the KPIs sessions and users, bounce rate, users by gender, pages per session and dwell time as well as the vertical scroll depth in percent (25%, 50%, 75% and 100%) per page.
Dangers of KPIs in the financial sector
Financial advisors often have clear sales targets as KPIs. This is why, for example, bank or insurance employees on the front line are forced to sell a predefined product range in order to achieve the specified targets. The higher the earnings of these financial products for the company, the higher the incentives. So advisors will inevitably become salespeople or eventually have to find another job. When talking to a financial services provider, it helps to ask yourself: is the conversation really an advisory discussion or more of a sales pitch? This is where an independent investment advisor or financial advisor without conflicts of interest can help.
Disadvantages of KPIs
Some other disadvantages of using KPIs are:
- The KPIs of different companies are only comparable to a limited extent (e.g. same industry).
- KPIs require a longer period of time to provide meaningful data.
- KPIs require constant monitoring and accurate tracking to be useful.
- They give managers the opportunity to “manipulate” the KPIs.
- Quality tends to decline when managers focus too much on productivity KPIs (extrinsic rather than intrinsic motivation).
- Employees can be put under too much pressure if their superiors focus specifically on KPIs.