Developing KPIs for Finance & Accounts Functions

Developing KPIs for Finance & Accounts Functions

A KPI for a function is a measurable value that demonstrates how effectively a function is meeting organizational objectives. KPI needs to be specific, measurable, realistic, and communicated to concerned key functional team members to accomplish.

How to develop KPI

For developing a robust KPI system,11 business activities are considered essential for any type of organisation, as below.

· 1. Sharing of corporate targets like Sales nos, Revenue, and costs & Completion targets with CFO

· 2. Design of format/contents of KPI with inputs from CEO/MD

· 3. Identify important KPIs based on corporate objectives and external influences like customer demand or & competitors’ offerings, or & economy or &statutory considerations

· 4. Proposing initial KPI Targets and Measures by each HOD of F&A function and review with CFO

· 5. Reviewing, modifying, and approving the F&A ‘s KPI by CEO/MD

· 6. Putting up measurement systems in place like reports /dashboards

· 7. Converting each functional KPI into KRA-Key result areas of functional team members at different levels i.e.

§ Higher level: directors-, CFO, HOD, General managers-GM, and so on as applicable

§ Middle level: senior manager-sr. mgr, manager, and so on as applicable

§ Lower level: assist. manager/junior mgr., staff, workers so on as applicable

· 8. Monthly capturing of actual accomplishment of KRA by respective teams in templates

· 9. Periodic review of Actual achievement of KPI vs. Target

· 10. In exceptional cases, reviewing, updating, and resubmitting KPI to CEO/MD

· 11. Compile Level-wise Actual vs. Target of KRA and forward updated reports to the HR team for each level's subsequent annual performance appraisal system.

Suggested Template for 30 identified KPIs -An Illustration

KPI for F&A functions has been broadly categorized under two categories, ie. Direct responsibility area and Indirect responsibility area

· Direct responsibility area. = 15 KPI -with 63% weightage

3 KPI rows have been assigned with weightage score@5 for each KPI with cumulative impact =15 score points as per illustrations below.

12 KPI rows have been assigned with weightage score@4 for each KPI with cumulative impact =48 score points as per illustrations below.

· Indirect responsibility area = 15 KPI with 37% weightage (F&A teams play facilitative roles)

7 KPI rows have been assigned with weightage score@3 for each KPI with cumulative impact =21 score points as per illustrations below.

8 KPI rows have been assigned with weightage score@2 for each KPI with cumulative impact =16 score points as per illustrations below.

Scoring methodology

The KPI measurement can be either quantitative or qualitative, and a few examples of quantitative KPI are as under

Quantitative KPI

· Profitability- In Rs or USD or %

· Cash flows - in Rs or USD

· Receivables - in Days or Rs

· Return on Investments- In %

· Solvency related KPI- In Ratios or %

and so on

In such cases, it is easy to compare performance based on Target vs. Actuals and compute % achievement based on scores earned and illustrations given.

Quantitative KPI

However, there can be many KPIs that may be both qualitative & quantitative in nature, such as below:

· IPO/Equity

· Long term borrowings

· Investments

· M&A/JV

· Board matters

In such cases, the scoring methodology is proposed below, wherein *1 mark has been indicated, highlighting the following.

*1=Indicates, the target value to be set up by the CFO in consultation with the CEO/MD at the beginning of each financial year as per the unit of measurement indicated. There can be KPI where it is difficult to quantify performance in Rs terms or % value or any other unit. In such a few cases, a score is given and assessed qualitatively on a 5-point scale, as highlighted below.

· 5 score indicates the highest performance

· 4 score shows very good performance

· 3 score indicates good performance

· 2 scores indicate below-average performance

· 1 score indicates poor performance

Scoring methodology-Column 7

In both Qualitative and Quantitative KPIs, the actual performance and score earned will be computed & captured in

Actual performance is to be captured by the appraising person supported by factual data from MIS, Financial books & with ERP/Other software support & measured in terms of UOM indicated earlier, with inputs from the appraisee.

The score earned (in Column 8) will be computed based on the actual value in column 7 divided by the target value in column 6.

S.no	Suggested KPI	Measure of accomplishment	UOM	% Weight- age	Target	Actual	Score earned based on col 7/6x5
Col1	Col 2	Col 3	Col 4	Col 5	Col 6	Col 7	Col 8
	Direct responsibility area	3 KPI rows each with weightage score@5 =15 score 12 KPI rows each with weightage score@4 =48 score
1	IPO/Equity	Pricing, roadshows,, %subscription, costs, equity & preference shares issuance & inflows & so on	Scale of 5	5	5 note*1
2	Long term borrowings	Borrowing rates/cost from banks/FI, covenants, Credit ratings received for Bonds & debenture, % interest rates Inflows-disbursals, EMI repayments, utilisation	Scale of 5	5	5 note*1
3	Investments	Risk analysis , % return on investments choices in Shares, Bonds, debentures, Mutual funds & so on	Scale of 5	5	5 note*1
4	M&A or JV	Due diligence, Price negotiations, Terms & conditions, statutory approvals, Forex hedging, ownership control % Royalty etc	Scale of 5	4	4 note*1
5	Board matters	Quarterly/annual results, Dividends, Corporate governance , /Audits & so on	Scale of 5	4	4 note*1
6	Cash flows from business operations during a perioud	Computations based on: Inflow from =customers, interest received, dividends, rentals etc , Outflows to = vendors, employees, taxes etc Notes: More heads can be added as relevant	Rs	4	?
7	Cash flows from investing activities during a perioud	Computations based on; Inflow from sales of =Assets, intangibles, co securities, & divestures, loans repayment by borrowers etc Outflows for purchase of =Assets, securities of other cos, acquisitions, investments made etc Notes: More heads can be added as relevant	Rs	4	?
8	Cash flows from Financing activities during a perioud	Computations based on: Inflow from sale of =Equities/stocks, preferred shares, bonds, etc Outflows for =Dividends, buy of treasury stocks, bonds, short term debts payments etc Notes: More heads can be added as relevant	Rs	4	?
9	Free Cash flow	Cash flow from business operations- Net capital expenditure	Rs	4	?
10	Cash burn ratio	Free cash flow during a specific period Divided by No of days during the period Notes: It indicates daily cash during the period. (-) Negative indicates company can go into financial distress	Rs (+ or -)	4	?
11	Operating cash flow to current liabilities	Cash flow from operations OCFCL= Divided by Average current liabilities Notes:It represents the net amount of cash derived from operating activities during the year and ability of the company to generate cash from operations to pay its debts	% or ratio	4	?
12	Solvency	Total liabilities Debt/equity ratio =. Divided by Total stockholders' equity	% or ratio	4	?
13	Liquidity	Working capital =Current Assets-Current liabilities	Rs	4	?
14	Liquidity	Current asset Current Ratio. = Divided by Current liabilities Notes: Current ration expresses working capital as a ratio .Value exceeding 1( one) indicate a positive net working capital . However ,excessively high current ratio indicates inefficient asset use	ratio	4	?
15	Operating cash flow to capital expenditure	Operating cash flow … Divided by Annual capital expenditure	% or Ratio	4	?
	Indirect responsibility area (F&A teams play facilitative roles)	7 KPI rows each with weightage score@3 =21 score 8 KPI rows each with weightage score@2 =16 score
16	Liquidity -Quick ratio	Cash + Short-term securities + Accounts receivable Divided by Current liabilities Note: The quick ratio reflects on a company's ability to meet its current liabilities without liquidating inventories that could require markdowns. Quick assets are those which are likely to be converted into cash within a short period of time. Value >1 indicates companies ability to meet its current liabilities without any difficulty	Times	3	?
17	Profits Margin	Earnings without interest expense Divided by Net sales revenue Notes: The higher %, indicates profitable operations	%	3	?
18	Gross Profit margin	Net Sales revenue - Cost of goods sold Divided by Net sales revenue Notes: % indicates how much every sale Rupee is gross profit. Higher the better	%	3	?
19	PBT	Profit before tax Divided by Net sales Notes: The higher %, indicates profitable operations	%	3	?
20	EBIDT	Earnings before interest, depreciation and tax Divided by Net Sales value Notes: The higher %, indicates profitable operations	%	3	?
21	Expense to sales ratio	Direct Expenses ETS=. Divided by . Net sales revenue Notes: It measures the percentage of each sales Rupee that goes to cover specific expenses..Lower the better	%	3	?
22	Return on Equity	Net income ROE= Divided by Average stock holder’s equity Notes: ROE measures the return on the investment made by the firm's stockholders. It is one of the primary measures of company performance for a specific period, usually a fiscal year.	%	3	?
23	Earnings/share	The net profit or loss for the period Divided by weighted average number of equity shares outstanding during the period Notes: Computation as per accounting standard 20	Rs	2	?
24	Dividend yield	Dividend per share Dividend yield = Divided by Market value per share Notes: Dividend per share is calculated based on the annual dividend declared during the year divided by the number of outstanding common stock	%	2	?
25	Return on Assets	Net income+ Interest expense net of tax saving ROA =. Divided by (Beginning total assets +Ending assets)/2 Notes: It measures utilization of assets to earn a profit. ROA measures the return earned on each Rupee that the firm invests in assets. Interest costs is excluded from the ROA calculation so that return is measured without the effect of debt financing.	%	2	?
26	Return on Financial leveler age	ROFL= ROE-ROA Notes: Financial leverage refers to the effect that liabilities (including debt financing) have on ROE. A firm's management can increase the return to shareholders (ROE) by effectively using financial leverage. On the other hand, too much financial leverage can be risky as too much debt increases chances of failure to make timely debt payments	%	2	?
27	Accounts receivable Turnover	Net Sales revenue ART= Divided by Average accounts receivable Notes: More turns indicate that accounts receivable are being collected more quickly	Turns	2	?
28	Days sales outstanding	365 Divided by Accounts receivable Turnover	Days	2	?
29	Average vendor credit days	Value of Accounts payable Divided by x 365 Cost of goods sold Notes: No of days payable to vendors	Days	2	?
30	Inventory turnover	Cost of goods sold INVT= Divided by Average inventory Notes: It measures the number of times during a period that total inventory is turned (sold). Higher no of times indicates that inventory is managed efficiently	No of times	2	?

How to populate the KPI template

· As is evident from the above table, a template (with 8 columns and 30 rows) has been proposed for the F&A function, which can be populated by the HOD of each function within the F&A team and reviewed by the CFO.

Each row represents a KPI parameter (along with the unit of measurement) with different weightages for each KPI.

For an easy-to-understand model, in column 5, the total of all the weightages of KPIs' must add up to 100,

· Essential inputs for computing actual accomplishment vis a vis each KPI are given in column 3.

· The values for the “Target” KPI and “Actual” vis a vis each KRA are populated in columns 6 & 7, respectively.

· After that score earned is to be determined as follows:

The actual value in column 7

Divided by X weightage score in column 5

Target value in column 6

The computation of the score earned is illustrated below for four random KPIs, each with different weightage of 5,4,3,2, respectively, in column 5. The values or numbers in cols 6 & 7 ,indicated in the illustration, are hypothetical.

· KPI parameters will undoubtedly vary from organisation to organisation, and weightages can be decided by CFO in consultation with CEO/MD.

· Therefore, at the absolute discretion, CFO can do the following:

§ Change the character/narration of each KPI and its measurement unit.

§ Add or delete or edit the KPI in consultation with CEO/MD

§ Change the proposed weightage @ 5 or 4 or 3, or 2 for KPI to any other number,

· However, for simplicity and to develop a Robust quantifiable model, the amended KPI's, overall weightage must add up to 100.

· In large organisations with multi-plants/offices in different countries/states/locations or companies with multiple end products or services, separate KPIs must be identified for each sub-functions of F&A.

· CFO can evolve KPIs for the above functions based on a similar approach with a focus only on relevant KPIs for each function

· For the service industry, KPI related to inventory will not be relevant, and end products will get replaced by “Services“ and cost of goods sold will get replaced by the cost of rendering services.

Illustration table for 4 KPIs

# mark in col 6 & indicates values considered in these cells are hypothetical and only for enhancing readers' understanding.

The score earned for 4 KPI’s=11 out of the target weightage of 14 (reflected in Col 5 and Col 8, respectively) and a similar methodology is to be applied for all 30 KPIs with a target weightage of 100 .

KPI S.no	Suggested KPI	Measure of accomplishment of KPI	UOM	% Weight- age	Target	Actual	Score earned	Computation For arriving at score based on values in col 7/col 6 x col 5
Col1	Col 2	Col 3	Col 4	Col 5	Col 6	Col 7	Col 8	Col 9
1	IPO/Equity	Pricing, roadshows,, %subscription, costs, equity & preference shares issuance & inflows & so on	Scale of 5	5	5	4	4	KPI’s measure is overall qualitative
6	Cash flows from business operations during a perioud	Computations based on: Inflow from =customers, interest received, dividends, rentals etc , Outflows to = vendors, employees, taxes etc	Rs	4	80Lacs #	60Lacs #	3	(60/80) x4 =3
16	Liquidity -Quick ratio For a perioud	Cash + Short-term securities + Accounts receivable Divided by Current liabilities Note: Value >1 indicates companies’ ability to meet its current liabilities without any difficulty	Times	3	1.10 #	6.2L+4.1L+8.6L Divided by 20.2L. # =0.93	2.54	(0.93/1.10).x 3=2.54
27	Accounts receivable Turnover For a perioud	Net Sales revenue ART= Divided by Average accounts receivable Note: More turns indicate that accounts receivable are being collected more quickly	Turns	2	9 #	6820L-sales Divided by (915L+1125L)/2 Avg Receivables =6.6	1.46	6.6/9 x 2 =1.46
Score earned for above 4 KPI’s=11 out of 14 (in col 5 and Col 8 respectively)				14			11

Activities that can adversely impact the business

Providing incorrect inputs to senior management -CFO/CEO/MD with malice intent of assigning easy targets/goals for KPI parameters.
In the workflow/embedded software (that enables accessing of KPI), incorporating incorrect parameters vis-à-vis management-approved parameters by not exercising prudence leads to inaccurate capturing of KPIs
Making changes in the KPI Targets or actuals before the performance review period with ulterior motives
Measures of accomplishment are deliberately kept vague and not merit-based, leading to the scope of manipulation.
Percent weightages assigned to each KPI are biased with ulterior objectives of influencing outcome vis-à-vis performance perspective.
Targets Set are biased (too stretched or loose) to reprimand or favour specific team levels /employees, leading to demotivation/dissatisfaction.
The actual measurement carried out is captured inaccurately or manipulated.

§ Through the back end of software, making circular changes in the KPI Targets or actuals during the performance review period, with ulterior motives and turning off the audit trail to prevent detection.

§ Not ensuring restricted access rights to KPI values in the appraisal software in HR, thus enabling unauthorised persons to make unauthorised changes in targets vis a vis approved KPI.

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Developing KPIs for Finance & Accounts Functions

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