How to Use KPIs to Improve Financial Performanceby Stacey Barr
We can improve financial KPI performance, like cash flow, revenue, costs, and profit, through its synergistic relationship with non-financial KPIs.
We often refer to KPIs or performance measures as either being financial or non-financial. The focus being on financial possibly stems from the capitalist bias of our economy, and the business world following advice like that of modern economist, Milton Friedman:
“There is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits.”
Robert Kaplan and David Norton, in their Balanced Scorecard, reinforced this perspective, quite literally, setting financial performance as the ultimate result that an organisation’s strategy should aim at. And if that’s the perspective you believe also, then following the Balanced Scorecard will be the answer to how to use KPIs to improve financial performance: just measure your Balanced Scorecard’s strategic objectives.
But even Milton Freidman evolved his views beyond this perspective:
“… so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.”
Since the introduction of the Balanced Scorecard, many academics, business leaders, consultants and authors have pushed to unblinker the perspective of what a business’s ultimate purpose really is, how financial performance is not the end game:
“Corporations doing business create side effects, and if they are not responsible for those side effects, the whole free market system breaks down.” – Scott Clooney, TriplePundit
To sustainably improve financial performance, don’t make it the end game.
Deception and fraud are not the only unintended consequences of making profit the ultimate KPI. The planet is an interconnected system, and no part of the planet operates in a vacuum, businesses especially.
- Inputs come from somewhere: what must be destroyed to make it possible for us to fill our cars with fuel?
- By-products go to somewhere: where do all the plastics we put into our recycled bins really end up?
- Operations have repercussions: how many people get sick or die as a consequence of intensive animal farming?
And the most fundamental interconnection of all is the exchange between an organisation and its customer: would any of us honestly want to support an organisation that cared more about its money than its mission?
The end game of any business that wants to survive and thrive has to be improving the lives of those who support it, without taking anything away from those impacted by it. And that’s more complex than the Balanced Scorecard’s linear cause-effect perspectives suggest.
Financial and non-financial performance don’t live in a hierarchy; but a system.
I wish we could ditch the categorisation of KPIs as either financial or non-financial. The divide makes little sense when we come to appreciate that organisations can only survive when they manage all the results that relate to the exchange they make with the market and part of the world whose continued support they rely on.
Money in a business is like blood in our body. It’s not the life in our body. Blood delivers the oxygen and nutrients that the parts of our body need to function well, so we can live well. Likewise, the money we all want to earn from a business also has the higher purpose of helping us live well. Money, like blood, is just one part that serves a function for the whole to survive and thrive.
Like the human body, an organisation’s results connect and relate with each other in a systemic way, not a linear cause-effect way. Ultimately, how long we survive depends on how well we manage the system as a whole.
To improve financial performance, understand the system dynamics.
The best way to understand the systemic interactions of the various results in our organisations is to map them. And we don’t just map the cause-effect interaction – we map the conflict, companion and lead-lag relationships too.
If we put a lens on financial results, we might see relationships like these in our map:
- Revenue and costs are companions, and both are a direct cause of profit.
- Costs is a conflict with accuracy or timeliness.
- Revenue is a direct effect of sales.
- Revenue is a lag effect of customer loyalty.
- Profit is a lag effect of employee engagement.
- Costs is a direct effect of rework and waste.
- Cash flow and profit are both direct causes of product innovativeness.
- Cash flow is a lag effect of customer loyalty and a direct effect of on-time and on-budget project completion.
With a map of these interactions, it’s easy to see that financial results are sometimes the cause, sometimes the effect, sometimes the conflict, and sometimes the companion to a range of other important results for overall organisational success.
KPIs help us improve financial performance to serve overall organisational success.
A systemic relationship map of both the financial and non-financial results for each organisation will be unique, like a personality. And it will contain the insights about how each organisation can improve its overall success at the same time as improving its financial health.
This means that the KPIs that help us improve financial performance will also be unique to our organisation. But with our systemic relationship map (in PuMP, our Results Map), we know what needs to be measured. No matter what the result is that needs to be measured, financial or non-financial, the procedure is the same every time: quantify the direct evidence of the result.
The KPIs we choose or create to measure the results in our relationship map will have the same relationships to one another as their results do. For example, let’s say:
- we measure revenue as Total Revenue
- we measure costs as Operating Cost
- we measure profit with EBITDA
Then (from example 1 above), Total Revenue is a companion KPI to Operating Cost, and both are causal KPIs for EBITDA. And thus, we have a system of KPIs (yes, financial and non-financial) that give us the information about what performance is doing, why it’s doing that, and what’s the best thing we can do to improve it.
So, financial health isn’t an independent, stand-alone, ultimate goal. Financial health is interdependent with overall organisational health. It’s both a cause and an effect of other results. It’s both in synergy and sabotage with other results. Financial performance cannot improve without the whole system improving too.
Financial performance is like our blood; it’s not the end-game, and it’s health is interdependent with the health of the entire system. [tweet this]
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