In my experience, many small business owners suffer from numerophobia. The second a business concept is expressed in numbers, what they understood easily and intuitively through words suddenly becomes confusing. Consequently, many small business owners never develop any real fluency with the key numbers within their business to the detriment of the performance of their business . A 19th Century british scientist called Lord Kelvin, famous principally for his work on the measurement of extremes of temperature, said
"When you can measure what you are speaking about, and express it in numbers, you know something about it. But when you cannot express it in numbers, your knowledge is of a meagre and unsatisfactory sort".
Ultimately, in order to to maximise the potential of your business, as the small business owner you will need to speak "numbers". But what numbers are important for small business owners to understand? The specific numbers can vary from business to business, but there are two different types of numbers that every small business owner needs to understand.
Lagging indicators are financial outcomes such as revenue, expenses, cash flow, profit, return on investment and other measures. They are considered lagging indicators because they measure past organisational performance that cannot now be changed. This historical data is useful to understand business strengths, weaknesses, performance trends and other business intelligence useful for decision making.
Leading indicators are the measures of key internal business processes. These are the true key performance indicators (KPI's) in small business as these numbers will determine the financial outcomes described by the lagging indicators. These are happening in real time and can be affected directly and immediately by an increase in effort or a change to aspects of the core business processes. An example of a leading indicator might be number of sales leads generated or number of orders processed. Leading indicators are rightly called KPI's because they are your early detection system that reveal business problems and diminished performance before it is too late. Most small businesses do not keep on top of their accounting data. They leave it to their accountants who in turn leave it to the very last minute to submit their annual accounts to Companies House. Consequently, small business owners are often only receiving a clear picture of the lagging indicators we mentioned earlier twenty one months after the period reported upon began. Clearly this information is not sufficently detailed to be useful in driving business performance or in guiding timely business interventions to keep your small business on track.
Both these types of numbers are important for small business. One type tell you what is happening and the other type tell you what happened. If you are only looking at what happened, you are not in control in your small business. Your understanding of the key internal processes in your business is unsatisfactory unless you can express that understanding in numbers. So we can see the critical importance of KPI's in managing a small business. When we talk of "managing by the numbers", these KPI's are the numbers we are talking about as these are the only numbers that you can actually respond to in time to make a difference to financial outcomes in your business. The lagging indicators cannot be altered because they have already happened. Once we as small business owners have accepted the importance of carefully selected KPI's as the drivers of business performance, the next question is how can I choose the right KPI's for my small business?
The process of choosing, monitoring and responding to these KPI's is the essence of learning to speak "numbers". Here are five steps that every small business owner needs to take to choose the right KPI's for their business and to use them to drive improved business performance.
The first thing I do when establishing a set of KPI's for a business is to draw a flow diagram of all the steps that are required to generate revenue. For example, in a business that supplies products to consumers the steps might be as follows:
Please note that KPI's are only a requirement for core business processes. KPI's are useful to improve performance within non core processes (e.g. somebody in association with the steps outlined above will need to send out an invoice and collect money). These are support activities for the core business processes. To distinguish which tasks in your small business are core and non core, just ask "can I skip this step and still have a chance of getting paid?". If not, chances are it's a core process. Focus on measuring core processes first and foremost. Make sure the support activities happen but measuring them is of secondary importance for a small business.
Having established the steps required to generate revenue, you then need to establish who is accountable for the successful completion of the specific tasks pertaining to that step. Following the logic of the example above, a sales manager might handle the initial enquiry and provide the quotation but the next three steps become the responsibility of the distribution centre manager. The next step is to outline the specific things that person needs to do in order to complete their step in a way that will make a positive contribution to the goals of your small business. For example, the sales manager might need to:
Obviously, the success or failure of this step is contingent on the factors outlined above. Once defined and shared, the sales manager is then accountable for doing all of the things that the business owner considers critical to success.
In the above example, there are six critical factors that need to be addressed in order for the step to be completed successfully. In my experience, these lists typically contain between five to ten points. Although any of these could be measured, one or at the most two should be chosen. Ideally, the person accountable for the desired results would be involved in the selection of the measures. There are two things to remember when it comes to selecting the right KPI's for a particular step.
Choose the KPI's and start to measure them. In the example above, I would choose conversion rate and customer retention rate as the KPI's for the sales manager. You will notice that the right KPI's will tell you something about the whole process. For example, if the sales manager was rude in handling the order, it is extremely unlikely that he will win the order and even less likely that the customer will re-order. If you are struggling to pick the right KPI's, always choose the KPI's that have the closest direct bearing on financial outcomes for your small business.
The final step is to set performance levels. These need to be aligned to business goals but also need to be believable to the people accountable for the delivery of the step. Again, the best KPI goals are drawn up with the people responsible for execution. To carry on our example to its conclusion, lets say that in consultation with the sales manager and with reference to the company goal this year of increasing turnover by 10%, a goal is established of increasing the conversion rate from 50% where it currently stands to 60% and of improving the customer retention rate from 60% to 75%.
Once these goals have been established, then regular review dates need to be established. The correct frequency for review depends entirely upon the KPI selected. For example, it would be hard to get a true idea of customer retention rate until the full twelve months being measured have elapsed. You would not want to wait twelve months, however, until you measured your conversion rate. This might most appropriately be measured monthly, fortnightly or even weekly depending on the length of the sales cycle for the products in question.
There are other things to consider when thinking about KPI's for your small business such as how your KPI's will relate to rewards. As I pointed out in a recent blog post, it is not enough to simply measure performance to drive improvement in your small business. Positive reinforcement is critical to drive improvements in the desired behaviours.
Here at Continuous Business Planning, we speak "numbers". If you need somebody to translate whilst you learn the lingo, please call us today. We'd be happy to help you install a suite of the right KPI's for your small business. We can even help you monitor these KPI's on an ongoing basis and make the necessary course adjustments that the numbers will tell you are required. If you just want to talk to somebody as you attempt to implement KPI's into your business, feel free to pick up the phone.