Peter Drucker, a leader in the development of management education, promoted business value as the primary goal of a firm.
Business value expands the concept of value beyond economic value (like profit) to include non-financial aspects of value like owner aspirations, employee talent, customer/supplier relationships, and process and data.
Key Performance Indicators (KPIs) are the instruments business owners use to understand an organization’s overall financial health – a prerequisite for making better financial decisions.
If you’re not using KPIs to manage your business, you’ll be at a competitive disadvantage compared to those MI business owners who are. It’s kind of like trying to fly an airplane, without instruments. Sooner or later, the plane is going to crash.
Imagine you’re about to make the most important financial decision of your life. You decided to sell your music store to two of your key managers and you want to figure out the selling price.
Your accountant completes a business valuation. You’re surprised that the value he places on your business is much less than you thought it would be and you’re wondering how this could have happened.
If you were successfully using the right set of KPIs to measure the financial and nonfinancial health of your company, chances are you could have avoided this unpleasant surprise.
The idea behind the “why” of using KPIs is simple: If you can’t measure it, you’re not managing it; If you’re not managing key value drivers like profit and customer satisfaction, financial prosperity is handicapped.
Here are four examples.
Example 1: Here’s how to use a financial KPI when faced with a decision. Suppose you’re trying to determine if you should invest in a new AV installation service for corporate and houses of worship. ROI (Return on Investment) is a great KPI to use to determine a “go” or “no go” decision. Often, the required data is readily available in your accounting system.
Here’s the word logic: You anticipate you will recoup an initial $20,000 cost of goods from the $32,000 in sales, leaving a profit of $12,000. Because the promotion was over a 90-day period, the company realizes a 60% return on its investment. Annually, the return is four times the 60% or 240% for annualized ROI.*
Here’s the formula: ROI = profit / cost X year days / period
$12,000 / $20,000 X 360 / 90
ROI = 60% X 4= 240% annual rate of return.
If you can hit your numbers and achieve a three-digit annual rate of return, you will have added significant value to your company. So, it looks like a “go.”
Example 2: Now let’s say you want to run a series of “what if” scenarios. For example, “In order to achieve a 20% annual growth rate, what increases in sales, and decreases in cost of goods and overhead will we require?” There’s a free tool on my website (details below) designed to show how owners can unlock the wealth in your business by using various KPIs like profit, revenue and cash. Check it out.
Example 3: Another non-financial KPI is Customer Retention Rate. According to Red Reichheld, author of The Loyalty Effect, “A 5% improvement in customer retention rates will yield between a 20% to 100% increase in profits across a wide range of industries.”
He reminds us that keeping the customers we already have and reselling them is a more effective strategy than trying to find and retain new customers.
It’s a simple formula to measure your Customer Retention Rate. CRR = number of customers at the beginning of a period divided by number of those customers that remained customers at the end of a period.
Let’s suppose you had 100 customers in January 2018 and you wanted to measure how many remained customers in January 2019. After reviewing your point of purchase system, you discovered you have 60 customers who remained loyal who continue to buy your products and services.
In this case 100 / 60 = 60% customer retention rate. Customer satisfaction leads to customer retention. Of course, if the customers are not profitable, you may not want to apply the royal treatment. That’s why customer retention rate KPI should be understood in the context of customer profitability.
Data for your customer retention ratio usually comes from your point of purchase system. A customer relationship management system (CRM) can also be very helpful to review the notes of past conversations. The Net Promoter Score, which I discussed in my April MMR column, is a quick and easy way to identify your loyal customers.
Here are three free resources to help you grow both profit and value.
• The ROI Institute offers free tools at https://roiinstitute.net/free-tools.
• CGMA Tool-” How to Develop Non-Financial KPIs.” (Google search)
• https://jaimieblackman.com/contact-us/requestValue-Creator I MoneyCapsules
As a reminder, I write to educate. I’m not permitted to give tax or legal advice, so always work with your professional advisors before making important financial decisions.
*Key Performance Indicators (KPI), Bernard Marr
Jaimie Blackman – a former music educator & retailer – is a certified wealth strategist and maker of Value-Creator | MoneyCapsules, which capsule value-creation activities into 90-day sprints. Blackman helps music retailers accelerate business value now and maximize value when it’s time to exit. Blackman is a frequent speaker at NAMM’s Idea Center. Visit jaimieblackman.com to subscribe to his free content and value creation tools.
