Businesses review their financial results every month. They look at the revenue, expense and net income. They compare the results for the month with the budget figures. They look up the assumptions made in the budget, investigate the activities that took place for the past month, and derive an explanation for the variance. The cycle repeats every month. Managers who have profit and loss responsibilities seldom like the idea of having to justify the unfavourable variances.
As a financial analyst in my early career, I always wondered why the budget figures were treated like the gold standard. Are we supposed to be perfect forecasters? Won’t the business be better off to focus on what it should do well to deliver good results?
We tend to place too much emphasis on financial results. A better approach is to measure critical activities a business must do well. For example, for a retailer to bring in solid revenue for the month, it needs to offer a great selection of products, drive a lot of visitors to the store, have sales associates readily available to offer help, entice every visitor to buy at least one item, and most importantly, there is stock available. If the retailer does these tasks well, the likelihood of a good month increases. In other words, by monitoring how well those tasks go, the retailer could tell what the monthend results would look like. In fact, the performance of these tasks provides an early warning system for the retailer. If stock out was a problem, it could work with the vendor and take corrective action. Proactive action would help to turn a potentially bad month around.
In monitoring performance, businesses need to track more than financial results. Here are three steps to identify what is important to monitor:
- Identify the core activities for the business —the core activities include work involved in converting input to a business into products and service it offers and delivers. For a retailer, the core activities include selecting and purchasing products for sale, allocating stock to the stores, and setting up the stores to serve the customers.
- Determine the critical tasks for each of the core activities —there are many tasks associated with the core activities. For example, purchasing involves approaching prospective vendors, identifying what products are suitable for your customer base, and placing the orders.
- Select relevant measures for the critical tasks —this involves picking what is meaningful to measure. Using the retailer example, a way to measure how effective the purchasing department is doing its job is to monitor inventory turns. Low inventory turns represent overstock situation. This implies money is tied up with idle inventory. Purchasing needs to adjust its purchasing practices.
These steps can be used to determine measures for a business, a department, a business unit, even a work process. The key idea is to decipher what is important to measure, other than the financial results. The exercise also helps to focus resources on the right activities and avoid wasting time and energy on the wrong work.