Build Your Company's Value with Key Performance Indicators
Many business owners base important decisions on their company’s financial information. However, traditional financial metrics don’t always show how a company is performing relative to its overall strategy. In order to build the value of your company and achieve sustainable growth, you need a way to measure progress towards your company’s strategic goals.
A key performance indicator (KPI) is a type of business metric that is meant to measure how effectively a company is achieving its strategic objectives. Because business strategies vary by company and industry, the KPIs used by one organization may not be appropriate for another.
How to Determine Appropriate KPIs for Your Company
KPIs can be different from other common business metrics in that they should reflect your company’s strategic goals. Your KPIs should provide you with actionable information that can be used to make decisions that reflect your company’s overall strategy and contribute to positive growth.
To identify which KPIs to use within your company, you should start by outlining your company’s strategic goals and identifying what actions you will need to take to achieve them. Once you’ve identified these actions, you will need to determine which metrics best describe how well you carry out those actions. These metrics will serve as your KPIs.
When selecting which metrics will serve as your KPIs, be sure that they are well-defined and easy to measure. Additionally, it’s best to select only a few KPIs so that progress is easier to monitor and digest. As you narrow down which KPIs to use, try focusing on those measuring core business activities that have the most significant impact on your company’s overall value.
To help illustrate how companies can use KPIs, we’ve provided a few examples inspired by some of our past clients in various industries.
One of our former clients, a durable medical equipment (DME) provider, relied on two KPIs commonly used across the healthcare industry: daily revenue per patient and cost per patient. The first indicator measured how much revenue was being generated by a patient each day they were under the care of one of the company’s client care providers. The cost per patient KPI helped the company monitor the costs associated with providing the clients’ patients with the equipment they needed.
The company contracted with care providers and charged a daily rate per patient depending upon the type of equipment needed (basic vs. high-end or specialty equipment). By monitoring revenue per patient in conjunction with cost per patient, the company was able to better negotiate favorable contracts and identify where it needed to reduce costs or increase rates in order to maintain its profit margins.
Inventory turnover is a common KPI used across various industries, especially in manufacturing. Manufacturing companies can track inventory turnover to measure how well it controls its inventory costs relative to similar manufacturers. By reducing excess inventory, manufacturers can eliminate unnecessary material and holding costs, which helps increase profit margins.
Inventory turnover is calculated by dividing the cost of goods sold (COGS) by the average dollar value of inventory on hand during a specific period. For example, if a manufacturing company’s COGS was $2.4 million in 2015 and the average value of its inventory that year was $1.2 million then its inventory turnover rate would be 2.0. If we see that other similar manufacturers have an inventory turnover ratio of 3.0, it could be a sign that the company is carrying excess inventory.
Tracking inventory turnover can also help you maintain steady cash flow during seasonal demand fluctuations. If you see that demand for your products has been historically lower during the winter, you will likely require less inventory in December and January than in the summer months. You could therefore produce less inventory to help offset the decline in revenue.
Distribution, Transportation & Logistics
Companies in the distribution, transportation, and logistics industries are generally concerned with on-time delivery of freight while maximizing profitability. Some KPIs commonly used across these industries include on-time delivery rate, revenue per mile, and cost per mile.
On-time delivery rate measures the percentage of deliveries that are made on time within a specific period. Companies can compare their on-time delivery rates to industry averages to determine whether they are more effective at meeting customer expectations than their competitors. If a company’s on-time delivery rate is low relative to industry averages, it may need to take action to improve its freight carriers’ performance, customer service, or other areas of its operations.
In the transportation and logistics industries, trucking companies often use revenue per mile as a KPI to help them measure how efficiently they use their assets to generate revenue. If you own a trucking company with $18 million in average annual revenue and your trucks travel approximately 6 million miles per year, then your company generates $3.00 in revenue per mile. If you are trying to manage your fleet more efficiently through improved scheduling and routing, revenue per mile can be a useful metric to help evaluate the impact of your changes.
In addition to revenue per mile, trucking companies often use cost per mile as a KPI, which measures the fixed, variable, and driver salary costs incurred for each mile traveled. Tracking cost per mile can help trucking companies monitor fluctuations in variable costs (e.g., including fuel, maintenance, and repairs) and better identify ways to reduce costs. When considered in conjunction with revenue per mile, it can also help determine the rates they need to charge on a per-mile basis to maintain profitability.
How KPIs Help Build Value
While the KPIs we discussed above are industry-specific, they are all intended to help business owners make better informed decisions that help drive revenue, control costs, and maximize profitability. The value of your company is determined primarily by how much earnings it generates and the risks your company faces. By selecting the proper KPIs, you will be better equipped to identify and mitigate risks before they impede progress towards your company’s strategic goals. Additionally, your KPIs will provide you with actionable information that can help you improve how well your company performs key business activities, which can have a direct, positive impact on your bottom line.
This document is for informational use only and may be outdated and/or no longer applicable. Nothing in this publication is intended to constitute legal, tax, or investment advice. There is no guarantee that any claims made will come to pass. The information contained herein has been obtained from sources believed to be reliable, but Mariner Capital Advisors does not warrant the accuracy of the information. Consult a financial, tax or legal professional for specific information related to your own situation.