4.2 - Evaluating Performance Using KPIs
Key Performance Indicators (KPIs)
A key performance indicator, or KPI, is a data point used to measure how well a business is performing, whether that's progress toward short-term and long-term goals or how effective its strategy has been. Managers pick KPIs that connect to the business's mission, its profitability, and its ability to stay competitive and viable over the long haul. Which KPIs matter most varies quite a bit depending on the type of business and its industry.
A good KPI is a specific number tied to a specific goal. If a business wants to grow online sales 20% this year, monthly online revenue is a useful KPI. A number like total social media followers wouldn't say much about that goal. KPIs also reflect the mission: a business whose mission stresses sustainability might track the share of its packaging that's recyclable.
KPIs depend on the industry, too. An airline watches on-time arrivals and the share of seats filled, a restaurant watches food costs and how quickly tables turn over, and a subscription app watches how many users cancel each month. Short-term goals use KPIs checked weekly or monthly (like sales this month), while long-term goals use KPIs tracked over years (like market share over the next five years).
Financial and Nonfinancial KPIs
Financial KPIs are measured in dollars or built from dollar amounts, like revenue or profit margin. Nonfinancial KPIs measure other things that drive success, like customer satisfaction, market share, or on-time deliveries. Businesses track both because nonfinancial problems (unhappy customers, late deliveries) usually show up in the financial numbers later. The examples below all use Ridge Coffee, a small coffee roaster that sells bags of coffee online and to local cafés. The financial KPIs come straight from the income statement and cash flow statement, so see 3.6 and 3.8 for how those are built.
Financial KPIs track a business's overall financial health, things like revenue, gross profit, gross profit margin (gross profit divided by revenue), operating profit, operating profit margin (operating profit divided by revenue), COGS, operating expenses, and cash flow.
KPI | How to calculate it | Ridge Coffee this year |
Revenue | Total sales of goods and services | $500,000 |
COGS | Direct costs of making the product (beans, roasting, packaging, production wages) | $300,000 |
Gross profit | Revenue − COGS | $500,000 − $300,000 = $200,000 |
Gross profit margin | Gross profit ÷ revenue × 100 | $200,000 ÷ $500,000 × 100 = 40% |
Operating expenses | Indirect costs of running the business (rent, marketing, office salaries) | $125,000 |
Operating profit | Gross profit − operating expenses | $200,000 − $125,000 = $75,000 |
Operating profit margin | Operating profit ÷ revenue × 100 | $75,000 ÷ $500,000 × 100 = 15% |
Cash flow | Cash coming in − cash going out during a period | March: $41,000 in − $45,000 out = −$4,000 |
A business can be profitable for the year and still have negative cash flow in a month, for example if cafés haven't paid their invoices yet (see 3.8). That's why cash flow gets its own KPI.
Marketing and sales KPIs track progress toward marketing and sales goals. These include customer acquisition cost, calculated by dividing total marketing, advertising, and sales costs by the number of customers acquired, along with customer lifetime value (the estimated total revenue from a customer over time), customer satisfaction ratings, customer retention data like repeat purchases or churn rate, total sales, and market share.
KPI | How to calculate it | Ridge Coffee this year |
Customer acquisition cost (CAC) | Marketing, advertising, and sales costs ÷ number of new customers | $12,000 ÷ 400 new customers = $30 per customer |
Customer lifetime value (CLV) | Average purchase × purchases per year × years as a customer | $20 × 3 orders a year × 4 years = $240 |
Customer satisfaction rating | Average survey or review score, or the percentage of customers who say they're satisfied | 4.6 out of 5 stars |
Customer retention rate | Customers at the start of a period who are still buying at the end ÷ customers at the start × 100 | 1,700 ÷ 2,000 × 100 = 85% (so the churn rate, the share who stopped buying, is 15%) |
Total sales | All sales revenue (or units sold) in a period | $500,000 |
Market share | The business's sales ÷ total sales in the market × 100 | $500,000 ÷ $10,000,000 × 100 = 5% |
As in 2.1, comparing CLV with CAC shows whether marketing pays off: Ridge spends $30 to win a customer who will spend about $240 over time, so its marketing is worth it.
Operations KPIs track progress on the operations side, including per-unit cost, delivery cost, order accuracy, and the percentage of deliveries made on time.
KPI | How to calculate it | Ridge Coffee this year |
Per-unit cost | Total production cost ÷ units produced | $300,000 ÷ 50,000 bags = $6 per bag |
Delivery cost | Total shipping and delivery costs, often shown per order (÷ number of orders) | $24,000 ÷ 6,000 online orders = $4 per order |
Order accuracy | Orders filled correctly ÷ total orders × 100 | 5,880 ÷ 6,000 × 100 = 98% |
On-time delivery rate | Deliveries that arrived on time ÷ total deliveries × 100 | 5,640 ÷ 6,000 × 100 = 94% |
Operations KPIs show where costs and problems come from, and they feed straight into the financial KPIs. Ridge sells its coffee for an average of $10 a bag. If its per-unit cost rose from $6 to $7, gross profit per bag would fall from $4 to $3, a 25% drop, even if sales stayed exactly the same.
Benchmarks and How They're Used
A benchmark is simply a reference point or standard used for comparison, which can be based on a business's own historical performance or on broader industry standards. Businesses compare their KPI data against these benchmarks to see how they're doing relative to that standard, helping them spot areas where they're meeting or exceeding expectations, and areas that need improvement.
Internal benchmarks come from the business's own past data, like last year's sales or last quarter's margin. External benchmarks come from outside, like industry averages from trade groups or a top competitor's published results. Here's how Ridge Coffee's KPIs compare with both:
KPI | This year | Last year (internal) | Industry average (external) |
Gross profit margin | 40% | 36% | 45% |
On-time delivery rate | 94% | 90% | 96% |
Customer retention rate | 85% | 80% | 75% |
Customer acquisition cost | $30 | $26 | $40 |
- Gross profit margin and on-time delivery improved from last year but are still below the industry average, so they're areas to work on (maybe a better price on beans or a faster shipping partner).
- Customer retention beats both benchmarks, a sign that customers are loyal.
- Customer acquisition cost went up from last year (for a cost, lower is better) but is still well below the industry average, so it's worth watching but not alarming.
Using only one benchmark can mislead. Beating last year doesn't mean beating competitors, and slipping from last year doesn't always mean falling behind the industry.