Key performance indicators (KPIs) in accounting

Key performance indicators are important for the successful management of an organization.

1. What are key performance indicators?

Key performance indicators (KPIs), are measures of performance in a unit or organization. Nowadays, companies have lots of data which can be used to improve operations and performance. However, using all available data may be impossible, time-consuming, and unnecessary. Instead, a set of a relatively few measures, if used properly, will be sufficient to analyze and improve performance and results.

Choosing appropriate key performance indicators depends on strategic or tactical goals of a company or units within it. The main purpose of KPIs is to help measure the achievement of specific goals; thus, establishing organizational goals would be the first step. Then, KPIs can be chosen to track progress towards these goals.

Key performance indicators can be lagging or leading. Lagging KPIs reflect a historical trend of a measure; such KPIs indicate what happened in the past. Leading KPIs are used to predict what the future of a measure will look like; such KPIs are oriented towards the future.

Key performance indicators can be financial and non-financial. Some examples of financial KPIs are presented below:

  1. Days of sales outstanding
  2. Inventory turnover
  3. Gross margin
  4. Profit margin
  5. Revenue growth
  6. Return on assets
  7. Quick ratio
  8. Debt to equity ratio

Some non-financial KPIs are:

  1. Number of new customer per month
  2. Percent of repeat customers
  3. Percent of on-time product deliveries
  4. Customer satisfaction score
  5. Employee engagement score
  6. Percent of projects completed on time and within budget

Let’s take a look at a financial key performance indicator. Days of sales outstanding (DSO) shows how many days on average it takes to collect payments from customers. In our example, the company has a DSO of 60 days, and the average accounts receivable balance is $5,000,000 at any point in time. The accounting department of this company performed research and identified that companies in the same industry have a DSO of 30 days. If the company can reduce its DSO from 60 days to 30 days, the working capital investment in accounts receivable will be reduced. The company would be able to free up $2,500,000 ($5,000,000 ÷ 2) and use those freed up funds for more productive purposes. Therefore, the company’s chief financial officer established a goal of reducing the DSO to 30 days. The DSO measure is now deemed to be a key performance indicator tracked by the accounting department on a monthly basis.

The accounting department also brainstormed ideas on how to improve DSO. Several action items were identified and put in effect:

  1. Offer customers a discount for fast payment.
  2. Deliver invoices to customers electronically to eliminate mail delivery time.
  3. Offer customers ways to pay electronically in addition to accepting checks.
  4. Reach out to customers before payment due dates.
  5. Assign a leader in the accounting department responsible for monitoring accounts receivable balances.

Within three months, the accounting department was able to shorten the company’s DSO from 60 days to 25 days. Going forward, the company will continue the newly established processes to ensure DSO does not start to increase again.

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