Financial risks are the uncertainties and potential losses that arise from the financial activities of a business. They can affect your cash flow, profitability, solvency, and reputation. To manage and mitigate these risks, you need to monitor and measure your financial performance using key performance indicators (KPIs).
KPIs are quantifiable metrics that reflect how well you are achieving your strategic and operational goals. They help you track your progress, identify strengths and weaknesses , and make informed decisions. KPIs can be divided into two categories: lagging and leading indicators. Lagging indicators measure the outcomes of past actions, such as revenue, profit, or return on investment. Leading indicators measure the drivers of future performance, such as customer satisfaction, market share, or innovation.
To drive maximum value KPIs should be synchronized with the strategic objectives and goals. The tracking of KPIs helps the company attain its objectives or take appropriate action. When setting the KPIs thresholds companies need to take cognisance of the risk appetite and risk capacity of the institution. The quality of the KPIs will determine their efficacy and value addition.
Choosing the right KPIs for your business depends on several factors such as industry, size, stage, vision, and objectives. Aligning them with your financial strategy and risk appetite is essential, as well as making sure they are relevant, specific, measurable, achievable, realistic, and timely. To help with this process, consider questions such as: what are the key financial risks you face or anticipate? How do these risks affect your financial performance and goals? What indicators can help detect, prevent, or mitigate these risks? And how can you collect, analyze, and report these indicators?
There are many standard KPIs that are standard for a reason. Install them in your business. Then ensure you have a metric to ground you in your WHY? Standard Gross Margin, Cost to Acquire a customer (CAC), Rule of 40 (EBITDA% + Revenue growth. Industry Then look at your industry and install the industry KPIs. maybe for retail it’s Revenue per Door. Hotels, revenue per available room, SAAS: Net Dollar Retention (NDR). You why From there add in your specific Why. If you are impact, it could be homeless given shelter, or lonely provided an ear. Whatever it is focus on why you are in business, to always ground you back to why you are doing this.
Using KPIs effectively involves setting clear targets, communicating them to your team, and reviewing them regularly. It is also beneficial to compare your KPIs with industry benchmarks, competitors, and best practices in order to identify gaps, opportunities, and threats. For instance, you can reduce credit risk by using KPIs such as accounts receivable turnover, bad debt ratio, or collection efficiency. Additionally, managing liquidity risk can be done through the use of KPIs such as current ratio, quick ratio, or cash conversion cycle. Similarly, controlling operational risk can be achieved by utilizing KPIs such as cost of goods sold, operating margin, or inventory turnover. And finally, mitigating market risk is achievable through the use of KPIs such as sales growth, market share, or customer retention.
Set the definition - stick to it Create a target Set tolerances to the KPI Monitor actual performance against it Act quickly. A KPI is used as an early warning sign so you can act decisively.
Improving your KPIs requires taking action based on the insights and feedback that you get from them. You should also review and update your KPIs periodically, as your business environment and goals may change over time. To do this, define and implement action plans to address the root causes of poor performance or high risk. Allocate resources and responsibilities to support the execution of your action plans, and monitor and evaluate the impact and effectiveness of your action plans. Additionally, celebrate and reward the achievements and improvements of your team, while learning from failures and mistakes in order to apply the lessons to future actions.
Communicating your KPIs is essential to ensure that everyone in your organization understands and supports your financial strategy and risk management. It's also important to communicate your KPIs to external stakeholders, such as investors, customers, suppliers, and regulators, to build trust and credibility. To do this effectively, consider using dashboards, reports, or scorecards to visualize and summarize your KPIs. You can also use stories, examples, or case studies to illustrate and explain them. Additionally, feedback, questions, or surveys can be used to engage and involve your audience in your KPIs. Furthermore, charts, graphs, or tables can be used to compare and contrast them. Finally, colors, symbols, or icons can be used to highlight and emphasize your KPIs.