How do you sort out KPIs to determine which ones assess current financial health vs. future financial health?
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CFOa year ago
To determine current financial health, one might look at KPIs that track current or most recent data (cash flow, portfolio returns, revenue streams, collection efforts ...) while determining the future entails interpreting KPI's that measure non-financial data such as geopolitical factors for example.
When it comes to KPIs you have to understand the KPI and what it means in order to know if it is a leading, coincident or lagging indicator. Note that this can change depending on who you are, what your industry is etc.
As an example, consider Sales. If you are a retailer then sales dollar per transaction is one KPI and we can call it a coincident indicator. If sales per transaction are down you would expect total sales to be down. If its not, then you know that more people came in but bought less per transaction. A good question would be to dig deeper to find out the connection between sales and profit.
Looking to the Income statement for the monthly, quarterly, annual sales would be a lagging indicator. This is because these numbers tell you what happened. They do not tell you what will happen.
If you want to look to leading indicators it may be more worthwhile to look at your marketing. For a retailer if you are opening stores and spending more on marketing the hope is that sales will increased. If this doesn't happen its definitely a good reason to look at your operations.
Note that the above does depend on who you are. For example if sales are trending down then trying to spend more on marketing or open new stores might he difficult. The firm will likely have to borrow money or raise more from investors. If your sales are trending down expect some pointed questions from bankers and or the stock market. Saying that you will issue more shares might reduce the value of your existing shares. In the end the lost value might me more than you expect to raise meaning that shareholders as a whole are worse off. If you are a stock analyst and you see sales trending down over a period of years its probably a good idea to take a look at your recommendation/rating of the stock. Hopefully you do this before sales trend down, i.e. if you see growth (increases) slowing down it might be a good idea to start changing how you position the stock. For example you might shift your language from saying that it's a growth story to a more mature, story. Your focus might shift towards how much cash is the company generating instead of how much cash the company needs to expand.
If you don't understand the impact of the KPI on your business, its just a number/metric. It has no meaning. If you do understand what the KPI drives, why and how, then the KPI will start to have meaning and then you'll know what metrics it leads, follows or matches.