Managing What We Measure

The standard statements used by organizations for financial reporting are the balance sheet, the income statement, and the cash flow statement. While these have been the standard for many years, and do a good job of providing some information on an enterprise’s health and performance, they paint an incomplete picture on their own. There are tools at our disposal, however, that can help offer some context to the information given in these standard statements and from other sources.

Key Performance Indicators (KPI’s)

There are often one or two key activities that an organization does that can make or break its success in achieving its mission. Measuring how well that activity is being done, then, would go a long way in determining what level of success we can expect in the future. This is what’s known as a key performance indicator (or KPI for short). Here’s an example: if we know that a key factor in business success is how quickly we reply to customer service inquiries, we should measure how often our responses to such inquiries occur within 24 hours. A poor result in this KPI tells you exactly what needs to be done in the future, too (improve response time). KPI’s should also always be non-financial because financial measures are lagging indicators by definition– by the time the money has been settled, the performance (or non-performance) that precipitates success (or failure) has already occurred.

Financial Ratios

As I mentioned before, the information given in the financial statements on its own may not be the most useful with respect to guiding decision-making. Thankfully, we can make better sense of this information by employing ratio analysis. A common financial ratio is the “current ratio” – current assets divided by current liabilities. This ratio gives us an idea of the solvency and liquidity of the organization because if current assets are outweighed by current liabilities (ratio is less than 1), we know that the enterprise is in danger of not being able to meet its debt obligations, and corrective action needs to be taken very soon. Two more examples of these ratios include the receivables turnover (how quickly customers are paying their bills; important for cash flow) and return on assets (measures profit against the amount of assets on hand; in other words, how efficient is the company at using its assets to generate profit).

Balanced Scorecard

This is a dashboard that shows performance and result indicators across four dimensions: customer, internal processes, learning & growth, and financial. It’s called a “balanced” scorecard because it gives the user a perspective on how well it’s performing in areas beyond the financial statements, thus balancing out the impact of financial statements on decision-making. On this scorecard, we measure how well we’re doing in how customers perceive us; how well we’re performing our internal processes; how much we’re improving our understanding of the organizational environment; and how well we’re delivering value to shareholders. If the company is doing well in all of these areas, then we can be confident that the company is set up well for future success.