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What Are KPIs and How to Use Them in Your Small Business?

If you’ve worked in a
corporate job, you probably know all about Key Performance Indicators (KPIs).
Large companies use them all the time to measure their progress and make sure
they’re on track to hit their targets.

But many small
businesses are missing a trick: A recent survey by Geckoboard found that nearly half of small and medium-sized business
owners have failed to identify any KPIs. The same survey found that those
businesses that do track KPIs
regularly were about twice as likely to hit their targets.

So in this tutorial,
you’ll learn how to apply this powerful planning tool to your small business.
You’ll learn what KPIs are, the benefits of using them, different types of
KPIs, and how to set effective KPIs and monitor them.

By the end, you’ll be
ready to use KPI reporting to take your small business to the next level of success.

What are key performance indicators KPIs
What are key performance indicators (KPIs)? (graphic source)

1. What Are KPIs?

Let’s start with a
quick definition. Here’s how business software company Klipfolio
defines KPIs:

A Key
Performance Indicator is a measurable value that demonstrates how
effectively a company is achieving key business objectives. 

The term “measurable
value” is important here. KPIs are driven by specific data, so that they
provide a clear measure of your progress. Instead of just saying, “Our
customers love us,” you’ll be able to say something like: “88% of customers say
they would buy from us again, up from 85% last year, and 82% would recommend us
to others, up from 80% last year.”

That’s much more
powerful than an anecdotal judgment, and it can help you by highlighting issues
and allowing you to deal with them quickly. If that customer satisfaction
percentage starts heading in the wrong direction, for example, you could run
extra surveys to find out exactly why people are less happy with your service.

It could be that you
have a particular employee who needs better training, or a competitor who
offers something you don’t, or something else. Your KPIs are like an early
warning system. When you don’t hit your targets, you can think of it as a red
warning light flashing in your office.

The example I gave is
of a customer satisfaction KPI, but you can use KPIs in different areas of your
business: you could use financial KPIs, operational KPIs, sales KPIs, and so on.
We’ll look at the different types in more detail later.

It’s also worth
highlighting that the Klipfolio definition uses the word “key” twice. What does
“key” mean? That depends on your business. A measurement that’s important for
one business may not be relevant to another. And what’s important to your own
business may change over time, as you grow and start to come across different
problems and opportunities.

We’ll look at choosing
KPIs in more detail later, but for now, just remember that “key” is a
subjective judgment, and it’s driven by what you want to focus on in your own
business at any particular time.

2. The Benefits of Using KPIs in Your
Small Business

So why use KPIs?

Well, the survey data
I mentioned in the introduction seems pretty compelling to me. Small businesses
that track KPIs regularly are twice as likely to hit their targets. Here’s a
more detailed look at why KPIs are so effective.

KPIs for Solo Entrepreneurs

If you’re a solo
entrepreneur, you’re probably trying to juggle about a dozen different jobs at
once, from accounting to product development to marketing. It can be easy to
end up with a to-do list a mile long but no real clarity around which tasks are
the most important in moving your business forward.

Setting and tracking
KPIs can keep you on track. If you’ve set them correctly, they reflect the most
important elements of your business right now. For each of the tasks on your
list, you can ask yourself how it will contribute to hitting one of your KPIs,
and prioritise accordingly. You can make sure that you spend the bulk of your
time on tasks that will have a direct impact on something that’s truly
important to your business.

KPIs for Businesses With Employees

If you have employees,
KPIs also serve some additional purposes. They not only help you and your employees
stay focused on the right things, but also give you the ability to manage your
employees more effectively.

If you employ a sales
manager, for example, you can agree on some realistic sales KPIs, and then
measure that person’s performance against the KPIs. It’s a more objective
measure, and it’s easier to keep the person on track. Instead of saying, “I’d
like to see you making more sales,” you can say, “The KPI we agreed on was to
bring in 20 new customers a month, but we’ve only brought in 12 this month.”

That can lead to a
much more productive discussion. Without the KPI in place, your sales manager
might get defensive about your vague desire for “more sales” and claim that
your expectations were unrealistic.

With the KPI, that
part is taken out of the equation. The sales manager has already agreed to the
target of 20 per month, and the discussion can focus on why that target has not
been met. Maybe they need more support from other areas of the business, maybe
the pricing is set too high, or maybe there’s a competitive disadvantage that’s
putting off potential customers.

KPIs can also help
your employees feel more engaged by setting clear expectations. That same
Geckoboard survey found that half of British staff say their overall
performance is compromised when they are not made aware of key company
information and metrics.

People love to know
exactly what’s expected of them, and to feel that they are making a real
impact. As your business gets bigger, that can be difficult to achieve, but
clear KPIs can help.

As you bring on more
employees, you can even use “cascading KPIs”. For example, if you have several
salespeople, you could split that overall KPI of 20 new customers per month, so
that each person is responsible for 5 new sales. Their individual KPI clearly
fits into an overall KPI.

The Limits of KPIs

KPIs are an important management tool, but
like all tools, they also have their limitations. Having a strong focus on a particular
target is great, but it can also lead to neglecting other important things that
aren’t captured in the data.

If you’ve set your KPIs correctly, they
should reflect the most important parts of your business, but still, data
viewed in isolation can always be misleading. It’s important to keep the
overall business context in mind.

Let’s return to that sales KPI example. In
that case, you’re incentivizing your sales team to bring in new customers, but
you’re not focusing on how valuable each customer is. Your sales team would do
better by bringing in five low-value customers than by attracting a single
large company that will spend huge amounts over a long period of time, even
though the latter would be more valuable for your business.

You could, of course, change the KPI to
focus on the lifetime value of each customer as a measure, but then
there could still be problems. If your sales team focuses purely on hitting the
KPI, they might end up delaying new customer signups once they’ve hit the
monthly number, so that the new business contributes to the following month’s
numbers instead.

So it’s important to remember, both for
yourself and for your staff, that doing the right thing for your business is
the main criterion for every decision. The KPIs are a means to that end, not
the end in themselves. Designing your KPIs correctly will take you a long way,
but still be sure to retain some flexibility, and don’t let the numbers become
an unhealthy obsession.

3. The Different Types of KPIs

So what types of KPIs
are there? Really, you can track anything you want to, and the areas will be
different for each company, but here are some popular examples:

Financial KPIs

This group of KPIs
measures the bottom line of your business: financial success. This could be
revenue, net income, cash flow, the health of your balance sheet, or something
more specific. For example, if debt is a problem for your business, your
overall debt level could be a KPI that you want to track.

For more on the debt
example, see my recent tutorial on getting out of debt, and for more
examples of financial KPIs, see this tutorial on financial metrics: 

Operational KPIs

These ones are about
the efficiency of your business operations. How quickly do you ship orders to
clients? If you have an inventory of physical products, how long do products
stay in that inventory before they’re sold? There are plenty of possibilities
here: for more, see my tutorial on operational metrics.

Growth KPIs

All businesses need to attract new
customers. Even if you don’t want to be the next Amazon, a certain amount of
growth is healthy—it helps give you more money to invest in your business and
provide the best possible service. At the least, you’ll need to replace the
existing customers that will depart over time for various reasons.

So you could track new customer signups,
lead generation, overall revenue growth, or a range of other metrics.

Customer KPIs

As well as bringing in new customers, you
need to keep the existing ones happy. This group of KPIs tracks the happiness
of your existing customers—usually based on regular surveys, although you could
measure it in other ways, such as the number of repeat purchases.

You could use a simple KPI like overall
customer satisfaction, or you could look at more detailed metrics like the
speed with which problems are resolved, levels of customer engagement with your
products or apps, interactions on social media, etc.

Leading/Lagging Indicators

You’ll often see KPIs
defined as “leading” or “lagging” indicators. “Leading” indicators predict a
particular outcome, whereas “lagging” indicators measure what’s happened in the
past.

Personally, I don’t
think this distinction is helpful. Measuring the future is logically
impossible, so everything you measure has already happened (and so is
“lagging”). But many of those past events can also be used to make predictions
about the future (and so are “leading”).

So I’d recommend
focusing more on the areas of your business that you’d like to track, but I
mention the “leading”/”lagging” distinction so that you’re aware of it.

More KPI Categories

You can see more KPI examples
in my series on business metrics, such as:

4. How to Set Effective KPIs

So which KPIs should you use?

First of all, here’s what not to do. Don’t start by asking
yourself what data you have available. Start by identifying the most important
things for your business, and then worry about how to collect the data later.

Most businesses these days have a huge
amount of data available, so don’t collect everything—that can be overwhelming
and distracting. Be selective, and make sure you’re collecting and tracking
only what’s most important.

What KPIs should you measure
What KPIs should you measure? (graphic source)

Choose KPIs Aligned With Your Strategic Objectives

So begin by referring back to your business
plan. (You do have a business plan, don’t you? If not, see my business planning tutorial.)

Even the most informal business plan should
have a clear list of strategic objectives. Begin with this list, and develop
KPIs to reflect each of the areas of most importance. 

British higher-education nonprofit Jisc provides a useful list of questions to ask yourself as you’re setting KPIs. Here’s a condensed version
of that list:

  • What questions are you hoping to answer
    through your KPIs?
  • Do these questions link directly to the
    strategic objectives outlined in your strategic plan?
  • Are you collecting the data required to
    answer these questions, or focusing simply on the data you know you can
    easily collect?
  • Are you collecting data unnecessarily?
  • How and how regularly are you going to
    monitor progress against your KPIs?

See the article linked to above for the full list of questions (but keep in mind that some of them
are more appropriate for larger institutions and may need to be customized to your small business goals).

Make the KPIs Effective

When you’ve identified
the right areas to focus on, you need to choose particular KPIs to measure.

The main thing to aim
for is specificity. KPIs should be sharply focused and measurable. You’re
probably familiar with SMART goals, if not, or if you need a quick refresher,
see this excellent tutorial by David Masters on setting goals for your small
business:

Briefly, SMART goals
should be:

  • specific
  • measurable
  • attainable
  • realistic
  • time-bound

KPIs are not exactly
like SMART goals. One difference is that whereas SMART goals usually have a
target date, KPIs are usually ongoing. But the framework is still helpful to
ensure that you set good, specific, measurable KPIs.

Define the Parameters

For each KPI, there should be a specific
minimum number that you’re aiming for. Think of my simple example of 20 new
customers per month.

Some businesses also like to include some
extra levels, such as a “traffic light” system. In that case, achieving the
target of 20 new customers per month might be green, indicating that you’re
doing well. Between 12 and 20 might be orange, indicating that you failed to
hit the target, but you got close. Less than 12 might be red, indicating that
you’ve got a serious problem to address.

5. How to Monitor Your KPIs

Of course, setting KPIs
is a pointless activity unless you actively monitor them on a regular basis and
take action as soon as you see a problem.

“How often should I
track KPIs?” you may ask.

The answer is: “As
often as possible.”

If you can, set up
some kind of dashboard that collects all of your data in one place and is easy
to update. Some accounting software offers this functionality, and there are
also plenty of specific “business dashboard” software providers that will pull
in data from multiple systems for you and allow you to track it in real time.

It all depends, of
course, on what data you’re tracking and how much you’re willing or able to
invest in software solutions. If you prefer to keep things simple, you can just
pull together the data yourself into a simple spreadsheet or database. Just be
sure that you, or someone in your business, make it a priority to do this
frequently.

If you’re not meeting
targets, it can be tempting to focus on bringing the number higher, but the
most important thing is to identify the underlying cause of the problem. This
may take time, but if you focus on it consistently for month after month, you
should see an improvement.

Over time, you’ll
probably need to refine your KPIs. You can do this as part of your regular
changes to your business plan. If your strategic objectives change, your KPIs
should change too.

And, although you may
be tempted to change the ones you keep failing to hit, the ones that may
actually need to be changed are those that you consistently achieve. If a KPI
is “green” for month after month, it may indicate that this area of your
business is doing fine and you don’t need to focus on it anymore. Or perhaps
you can consider setting a more aggressive target.

The bottom line is
that you need to track your KPIs regularly, take action when you’re not meeting
targets, and refine your KPIs to ensure that they reflect progress against your
company’s most important objectives.

Conclusion

In this tutorial, you’ve
learned what KPIs are and how they can help your business. You’ve seen some
examples of different types of KPIs, and you’ve learned how to set effective
KPIs. Finally, you’ve learned how to monitor your KPIs regularly and how to
refine them to ensure they stay relevant.

So you’re now ready to
set KPIs for your own business. Use the process we’ve covered today, make sure
that you’re only tracking what’s really important, and then make sure you track
it as often as possible and update the KPIs whenever you need to. If you do all
that, you should be well on your way to joining that minority of small businesses
that successfully achieve all their targets.