Management Accounting 101: Performance Measurement and Control - Key Performance, Indicators KPIs Leading vs. Lagging Financial vs. Non-Financial

What This Is

Key Performance Indicators (KPIs) are metrics used to measure a company's performance and progress toward its goals. Effective KPIs help managers make informed decisions, allocate resources, and drive strategic growth. For instance, Toyota uses KPIs like "Manufacturing Lead Time" and "Quality Defects per Unit" to optimize its production processes and improve customer satisfaction.

Key Frameworks & Metrics

• Break-Even Point (units) = Fixed Costs / Contribution Margin per Unit – tells you how many units must be sold to cover all costs. For example, if a company has fixed costs of $100,000 and a contribution margin per unit of $10, use this formula to determine the break-even point.
• Economic Value Added (EVA®) = NOPAT? (Capital Invested × WACC) – measures true economic profit after charging for the cost of capital. Amazon's EVA can be calculated using its net operating profit after taxes (NOPAT) and capital invested.
• Return on Investment (ROI) = Net Income / Total Assets – measures the return on investment for a project or business. Dell uses ROI to evaluate the profitability of its product lines.
• Balanced Scorecard (BSC) – a framework for measuring performance from four perspectives: financial, customer, internal processes, and learning and growth. Southwest Airlines uses a BSC to track its performance in these areas.
• Activity-Based Costing (ABC) – a method for assigning costs to products or services based on their consumption of resources. ABC helps companies like General Electric to identify and eliminate waste in their production processes.
• Variance Analysis – a technique for analyzing the difference between actual and budgeted costs or revenues. Toyota uses variance analysis to identify areas for cost reduction and process improvement.
• Residual Income = Net Income? (Capital Invested × WACC) – measures the return on investment for a project or business, considering the cost of capital. Residual income is used by companies like Amazon to evaluate the profitability of their projects.
• Customer Satisfaction Index (CSI) – a metric for measuring customer satisfaction. Companies like Dell use CSI to track customer satisfaction and identify areas for improvement.
• Employee Engagement Index (EEI) – a metric for measuring employee engagement. Southwest Airlines uses EEI to track employee satisfaction and retention.

Step-by-Step Process

1. Identify the KPIs: Determine the key performance indicators that align with the company's strategic objectives.
2. Set targets: Establish specific, measurable, achievable, relevant, and time-bound (SMART) targets for each KPI.
3. Track and measure: Collect and analyze data to track progress toward the targets.
4. Analyze and interpret: Use statistical techniques to analyze and interpret the data, identifying trends and areas for improvement.
5. Take action: Implement changes and interventions to address areas for improvement and achieve the targets.
6. Review and adjust: Regularly review and adjust the KPIs and targets to ensure they remain relevant and effective.

Common Mistakes

• Mistake: Treating all costs as relevant when using ABC.
• Correction: Only consider costs that are directly related to the product or service being produced.
• Mistake: Ignoring qualitative factors in make-or-buy decisions.
• Correction: Consider both quantitative and qualitative factors, such as strategic fit and supplier reliability.
• Mistake: Using ROI alone without considering residual income or EVA.
• Correction: Use a combination of metrics to evaluate the profitability of a project or business.

Decision-Making Tips

• When faced with a make-or-buy decision, always isolate avoidable costs and consider strategic, not just quantitative, factors.
• When evaluating a project, consider both the financial and non-financial benefits and costs.
• When tracking KPIs, use a combination of leading and lagging indicators to get a complete picture of performance.

Quick Practice Scenario

A division rejects a project because its ROI would drop from 18% to 17%. By how much would residual income change if the project cost is $1M and the required rate of return is 12%?

Answer: Residual income would decrease by $20,000 (=$1M x 8% = $80,000 - $60,000 = $20,000).

Last-Minute Cram Sheet

• Break-Even Point (units) = Fixed Costs / Contribution Margin per Unit
• Economic Value Added (EVA) = NOPAT? (Capital Invested × WACC)
• Return on Investment (ROI) = Net Income / Total Assets
• Balanced Scorecard (BSC): a framework for measuring performance from four perspectives
• Activity-Based Costing (ABC): a method for assigning costs to products or services based on their consumption of resources
• Variance Analysis: a technique for analyzing the difference between actual and budgeted costs or revenues
• Residual Income = Net Income? (Capital Invested × WACC)
• Customer Satisfaction Index (CSI): a metric for measuring customer satisfaction
• Employee Engagement Index (EEI): a metric for measuring employee engagement
• 'Fixed costs' are only fixed in the short run within a relevant range – outside that range, they can change.
• ROI alone is not enough to evaluate the profitability of a project or business – consider residual income or EVA as well.