What Are Key Performance Indicators (KPIs)?
Key performance indicators (KPIs) refer to a set of quantifiable measurements used to gauge a company’s overall long-term performance.
KPIs specifically help determine a company's strategic, financial, and operational achievements, especially compared to those of other businesses within the same sector.
- Key performance indicators (KPIs) measure a company's success versus a set of targets, objectives, or industry peers.
- KPIs can be financial, including net profit (or the bottom line, gross profit margin), revenues minus certain expenses, or the current ratio (liquidity and cash availability).
- Customer-focused KPIs generally center on per-customer efficiency, customer satisfaction, and customer retention.
- Process-focused KPIs aim to measure and monitor operational performance across the organization.
- Generally speaking, businesses measure and track KPIs through business analytics software and reporting tools.
Key Performance Indicators (KPI)
Understanding Key Performance Indicators (KPIs)
Also referred to as key success indicators (KSIs), KPIs vary between companies and between industries, depending on performance criteria.
For example, a software company striving to attain the fastest growth in its industry may consider year-over-year (YOY) revenue growth, as its chief performance indicator. Contrarily, a retail chain might place more value on same-store sales, as the best KPI metric in which to gauge its growth.
Key performance indicators (KPI) gauge a company's output against a set of targets, objectives, or industry peers.
Types of Key Performance Indicators (KPIs)
Key performance indicators tied to the financials typically focus on revenue and profit margins. Net profit, the most tried and true of profit-based measurements, represents the amount of revenue that remains, as profit for a given period, after accounting for all of the company's expenses, taxes, and interest payments for the same period.
Calculated as a dollar amount, net profit must be converted into a percentage of revenue (known as "net profit margin"), to be used in comparative analysis.
For example, if the standard net profit margin for a given industry is 50%, a new business in that space knows it must work toward meeting or beating that figure if it wishes to remain competitively viable. The gross profit margin, which measures revenues after accounting for expenses directly associated with the production of goods for sale, is another common profit-based KPI.
A financial KPI that's known as the “current ratio” focuses largely on liquidity and can be calculated by dividing a company's current assets by its current debts.
A financially healthy company typically has sufficient cash on hand to meet its financial obligations for the current 12-month period. However, different industries rely on different amounts of debt financing, therefore a company ought to only compare its current ratio to those of other businesses within the same industry, to ascertain how its cash flow stacks up amongst its peers.
Customer-focused KPIs generally center on per-customer efficiency, customer satisfaction, and customer retention.
Customer lifetime value (CLV) represents the total amount of money that a customer is expected to spend on your products over the entire business relationship.
Customer acquisition cost (CAC), by comparison, represents the total sales and marketing cost required to land a new customer. By comparing CAC to CLV, businesses can measure the effectiveness of their customer acquisition efforts.
Process Performance Metrics
Process metrics aim to measure and monitor operational performance across the organization.
By dividing the number of defective products by total products produced, for example, businesses can measure the percentage of defective products. Naturally, the goal would be to get this number down as low as possible.
Throughput time represents the total amount of time it takes to run a particular process. For example, a drive-through restaurant throughput can measure how long it takes to service an average customer; from the time they make their order to the time they drive away with their food.
Examples of Key Performance Indicators (KPIs)
Let's take a look at electric vehicle-maker Tesla (TSLA) for a few examples of KPIs in real life. These numbers are all from their Q1 2021 earnings release.
During the quarter, Tesla produced a record 180,338 vehicles and delivered nearly 185,000 vehicles. Production is a big deal for the company because it has consistently been criticized for being bad at ramping up.
Increased manufacturing scale means more market share and profits for Tesla.
Automotive Gross Margin
For the quarter, Tesla's automotive gross margin expanded by one percentage point to 26.5%. Gross margin is one of the best measures of profitability for Tesla because it isolates its vehicle production costs.
Tesla managed to expand its gross margin in Q1 even as sales of lower-priced models outpaced its higher-margin models.
Free Cash Flow
Tesla's free cash flow clocked in at $293 million during the quarter. That represents a vast improvement from the $895 million free cash flow loss in the year-ago period.
Tesla's current level of free cash flow production suggests that the company is reaching a scale of profitability without the help of regulatory credits.
Limitations of Using Key Performance Indicators (KPIs)
Some of the disadvantages to using KPIs include:
- The long time frame required for KPIs to provide meaningful data
- They require constant monitoring and close follow up to be useful
- They open up the possibility for managers to "game" KPIs
- Quality has a tendency to drop when managers are hyperfocused on productivity KPIs
- Employees can be pushed too hard aiming specifically for KPIs
KPIs do not necessarily have to be solely tied to financial data.
While profits and debt levels are indeed important key financial indicators, a company’s relationships with both its customers and its employees are no less important to establishing its general health.
Common non-financial KPIs include measures of foot traffic, employee turnover rates, the number of repeat customers versus new customers, and various quality metrics.
What Is a KPI Example?
One of the most basic examples of a KPI is Revenue Per Client (RPC). For example, if you generate $100,000 in revenue annually and you have 100 clients, then your RPC is $1,000.
What Are the 5 Key Performance Indicators?
KPIs vary from business to business. But in general, five of the most commonly used KPIs include:
- Revenue growth
- Revenue per client
- Profit margin
- Client retention rate
- Customer satisfaction
How Do You Measure KPIs?
It depends on the actual KPI being measured. But generally speaking, businesses measure and track KPIs through business analytics software and reporting tools.
What Is a Good KPI?
A good KPI has the following attributes:
- Provides objective and clear information of progress towards an end-goal
- Tracks and measures factors such as efficiency, quality, timeliness, and performance
- Provides a way to measure performance over time
- Helps make more informed decisions
How Do I Create a KPI Report?
Follow these general steps to create a KPI report:
- Create an overview or introduction
- Clearly define the KPIs
- Present your KPIs using appropriate graphs, charts, and tables
- Make final edits to the report and distribute
The Bottom Line
KPIs offer an effective way to measure and track a company’s performance on a variety of different metrics. By understanding exactly what KPIs are and how to implement them properly, managers are better able to optimize the business for long-term success.