Financial planning and analysis (FP&A) which is an important department within the Finance function, is responsible for providing the organisation with the insights they need to make operational, financial, and strategic decisions. Specifically, the main objective of FP&A is to transform the company’s business performance using digital, data and analytics. However, one key component that acts as a backbone for FP&A performance is the Key Performance Indicator (KPI).
What exactly is a KPI?
Why are the KPIs an important component in FP&A? What can organisations do to design and build a robust KPI framework and deliver improved business performance?
Let us first start by understanding the KPIs. A KPI is a quantifiable measure used to evaluate the success of the FP&A organisation in meeting its performance objectives. A good KPI framework covers the leading (predictive and prescriptive insights) and lagging (descriptive insights) metrics. Descriptive insights help to answer the question “what happened?”, predictive insights answer the question of “what will happen?” and prescriptive insights answer the question “what should be done?” Basically, if a business entity including the FP&A function is using KPIs to measure its performance, those KPIs typically drive business behaviour, results, and the organisation culture.
What is the business impact of KPIs? Why should the FP&A team pursue KPIs?
In other words, strong FP&A performance management is based on the fundamental principle that “what gets measured gets done.” KPIs provide the visibility to measure and manage business performance. Aberdeen Group examined the use of KPIs in more than 350 enterprises and found that the best-in-class companies derive performance improvements, including of 10 per cent increase in the time-to-decision making; 9 per cent increase in both profitability and revenue growth; and customer performance improvements of 9 per cent in both net-new customers gained and customer satisfaction.
How can an FP&A organisation design and build a robust KPI framework?
There is no one-size-fits-all when it comes to choosing the "right" KPIs for your business. Building the FP&A KPIs framework that is specific to your organisation starts by formulating powerful questions. Questions are important as they provide the context to the insights or KPIs. One important factor to consider while formulating good questions is the framing bias. The framing bias is a cognitive bias that impacts decision making based on the manner in which the question is formulated. Given that we are all influenced by the manner in which the question is presented. For example, take two vendors whose quality of delivery needs to be assessed. One vendor performance says “10 per cent defects” and another says “90 per cent defect-free”. The framing effect will lead to us picking the second option because human beings tend to value options that are framed positively. Hence having the KPI definition i.e., “defect-free” or “defect prone” is very important as it impacts the data selected and ultimately the decisions made from the KPIs.
So how can an FP&A function implement a good KPI framework? First and foremost, the questions in formulating the KPIs should be tied to the strategic objectives of the business - the value drivers. Once the right questions are selected for the KPIs, three foundational elements discussed below should be factored in building a strong FP&A KPI framework. FP&A teams should be very careful in selecting KPIs because the wrong KPIs can potentially harm the organisation.
- Reliable Insights. While there is a natural inclination in every business and in every individual to know more, one needs to evaluate how these insights from the KPIs will be used for making decisions. Albert Einstein once said, “not everything that can be counted, counts.” However, trying to analyse all the data to derive insights might be expensive and time-consuming. Instead, try forming a hypothesis or a logical proposition as the hypothesis will provide you with an indicator of what data to acquire whilst helping you to stay focused. Once a good hypothesis is formulated, design the KPI model, by asking these important questions for an accurate and deep understanding. Why do you want to know - articulate the root cause? How much do you want to know – the scope? What is the value of knowing and not knowing – the strategy to convert insights into actions? This begs the question on the recommended number of KPIs in the framework. Cognitive science researchers believe that human beings can normally cope with just five to nine pieces of information at a time and this figure is popularly known as the “Magic Number”. This means 7 +/- 2 KPIs (leading and lagging) is the recommended count of KPIs in the KPI framework or FP&A dashboard.
- Accountability. While designing and implementing the KPI framework is complex, more challenging than that is realising the change; integrating the insights from the KPIs into a business’s operating model is very difficult. While change is inevitable, it can often be uncomfortable. How effectively can we use these insights and bring change in operations, compliance and decision making? How can KPIs be an active part of FP&A operations? Successful change initiatives are often associated to accountability. This means having an accountable FP&A leader who is close to the KPI being tracked for performance. For example, if the KPI is on “Days Payable Outstanding (DPO)” to improve the cash conversion cycle (CCC), it is advisable to have the Account Payable (AP) Manger track and improve the DPO KPI.
- Quality Data. Finally, reliable KPIs are dependent on quality data given that most businesses are plagued with quality data. Research published in Harvard Business Review says that just 3% of the data in a business enterprise meet data quality standards. But how do you define quality data? Data is considered to be of good quality if they are fit for use in operations, compliance, and decision making. In this backdrop, while quality data in business is contextual (based on time, location, data consumers, business environment, and so on) and multidimensional (such as accuracy, correctness, completeness, timeliness, and more), defining the context and selecting the pertinent data quality dimensions will help decision-makers trust the insights offered to them thru the KPIs and ultimately help them make better decisions.
While many FP&A teams do a great job in identifying the consumers of the insights coming from the KPIs, unfortunately, the goals of the insight consumers are often not very clearly defined and do not align with the larger objectives of the enterprise. In January of 2019, research advisory firm Gartner reported that 80% of data analytics insights did not deliver business outcomes. One effective solution is formulating a good objective statement by asking questions, formulating a hypothesis, and defining the performance KPI framework based on the three key elements discussed above. Management guru Peter Drucker once said - “You cannot manage what you cannot measure”. In other words, insights from KPIs offer FP&A performance visibility, and visibility provides business value.
- Gartner, “Our Top Data and Analytics Predicts for 2019”, https://blogs.gartner.com/andrew_white/2019/01/03/our-top-data-and-analytics-predicts-for-2019/, 2019
- Hatch David, “Making Smart Decisions: The Role of Key Performance Indicators”, https://esj.com/Articles/2007/10/30/Making-Smart-Decisions-The-Role-of-Key-Performance-Indicators.aspx?Page=1, Oct 2007.
- Miller, George, “The Magical Number Seven, Plus or Minus Two: Some Limits on our Capacity for Processing Information”, Psychological Review, 1956.
- Nagle, Tadhg; Redman, Thomas, and David Sammon, “Only 3% of Companies’ Data Meets Basic Quality Standards”, https://bit.ly/2UxaHO4, Sep 2017.
- Southekal, Prashanth, “Data for Business Performance”, Technics, 2017
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- Southekal, Prashanth, “Finance Transformation and the Future of FP&A”, https://fpa-trends.com/article/finance-transformation, Sept, 2021