Measuring how your business is performing

1. Why measure your business performance?

Think of your business plan or strategy as a route map. with your goal being the point you want to travel towards. 

Having decided your goal, you set your objectives. Then, using the right business performance metrics - both financial and non-financial - helps you check whether you are on track for success, guides you to take informed decisions, and helps you preempt and manage any problems and risks.

The best measures vary for different businesses

What success looks like is different for every business, so the most suitable measures will vary, including:

• size and stage - e.g. whether you are a start-up trying to evidence there is demand for your offering, or an established business with several staff looking to improve efficiency

• sector - e.g. a plumber will measure different activities from a cafe or ecommerce business

• objectives and strategy - e.g. whether your priority is developing new products, increasing margins, or cutting costs.

Some situations will require you to have certain measures in place, for example, if you are:

• obtaining investment, loans or grants

• securing and monitoring delivery against customer contracts

• evidencing regulatory compliance.

Avoid common mistakes

When measuring performance, there are a few traps to avoid:

• not measuring anything at all - which leads to you losing track of where you are and where you’re going, therefore becoming reactive rather than proactive

• measuring the wrong metrics - which won’t give you useful information or help your decision making

• measuring and reporting on far too many metrics - which wastes time and resources and can cause confusion.

2. Business goals, strategy and objectives

Your business plan will outline your goals, objectives and strategy.

Goals and strategy

Usually business goals will have a main financial driver such as becoming profitable to survive, improving overall profitability, or increasing revenue.

Many different approaches can be taken to achieve your business goal, and the approach you choose will become your overall strategy. 

For example, to increase revenue you could:

• sell more to existing customers

• move into new geographic markets

• diversify with new products and services

• or even buy another business.

Objectives

Some small businesses will look ahead for the next year or two, but others will set longer-term objectives for the next three to five years.

Regardless, your business objectives must align with your goals and strategy. Once you have decided your goals, set clear and manageable business objectives to help you get there, e.g. increase sales to existing customers by 20% in the next 6 months.

3. Setting SMART objectives

Many businesses set targets in the form of SMART objectives. These can act as stepping stones, helping to focus energy and activity across the organisation, making it more likely you will stay on the right path to achieve your overall goals. 

Making them SMART

SMART objectives are specific, measurable, actionable, relevant and time-driven.

• Specific. The objective must be specific enough to pinpoint exactly what needs to be achieved. 

• Measurable. It must be possible to measure this objective and define the specific metrics you will use.

• Actionable. The measure must be one that you can act on and realistically achieve. You need to set ambitious targets that will motivate and inspire your employees but they must be achievable and, ideally, action-focused - e.g. ‘reduce response time’ can prompt more action than a general ‘improve customer service’.

• Relevant. It must directly relate to the overarching business goal.

• Time-driven. It must detail when the objective needs to be achieved and should be able to be measured against different time periods. People's progress towards a goal will be more focused if they understand the deadlines against which their progress will be assessed.

So for example, if your purpose is to generate more new product sales from your existing customers, one of your SMART objectives could be:

To achieve 45 sales of the new colour through the website in the next 6 months, from customers who have bought within the last 12 months.

Choose your KPIs

You need to identify the key metrics that will be most useful for informing decisions in your business and tracking progress against your SMART objectives. These are often referred to as key performance indicators (KPIs). They must relate to aspects of the business environment over which you have some control. 

For example, interest rates may have a crucial impact on performance for a given business, but you can't use the Bank of England base rate as a KPI because businesses have no power to change it. Instead you would have to set a KPI related to your exposure to interest rate fluctuations.

KPIs will vary for each objective and some KPIs may be specific to departments or teams. 

Example KPIs

A business that has identified that improving customer service is critical to increasing sales might identify  KPIs for elements that have the biggest impact on delivering and monitoring their customer service levels such as:

• order fulfilment time - speeding up the time it takes to complete an order

• response time - improving the percentage of incoming calls answered within 30 seconds

• number of complaints received - reducing the number of customer complaints received overall or in specific areas

• number of customer returns - reducing the number of returned items overall or on items where there have been disproportionate returns.

A company seeking to increase revenue by gaining new customers in a new location might identify KPIs including:

• volume of new customers from location - increasing the number of new customers from the new location and monitoring how it compares with other locations

• average order value - achieving profitable orders

• cost of customer acquisition - ensuring the cost of acquiring new customers is proportionate to the sales  

• total revenue from area - making sure the new location is sustainable.

None of these KPIs are necessarily better than any other. The challenge is to find which specific indicators are most useful for tracking your performance to help you achieve your objectives.

4. Financial performance measures

All businesses must meet their obligations around accounts and bookkeeping. Annually, you will produce profit and loss accounts and a balance sheet, but this is historical data for the previous year. To make effective decisions, all businesses need to understand their current financial position.

Sales

You need to track sales monthly to understand the relationship between customer demand, your pricing and your volume of sales. 

In some sectors, seasonality is a key variable to take into account, for example in travel, tourism and hospitality, where you will expect fluctuations related to holiday periods.

Example metrics that might be useful include:

• total revenue - total income generated from all sales compared with previous month and same month last year

• sales volume - comparing the number of units sold this month with last month, and this month against the same month last year

• average sales value - the average value per unit sold compared with previous calendar month and same month last year

• sales pipeline length - how long the sales pipeline is from enquiry or initial interest to conversion (often more useful for more complex products and services)

• sales growth rate - the percentage increase in sales revenue over a set time period.

These numbers will help you understand whether your pricing and marketing is working. For example if you have a greater volume of sales but less revenue, then maybe your pricing is too low as a result of too many special offers and discounts. Or if the number of sales is falling, maybe you need to adjust pricing and increase marketing.

Profitability

It is vital to measure profitability because even if sales have dramatically increased, it is possible for a business to collapse if costs are too high. There are various margins to look at:

• gross profit margin - how much money is made after direct costs of sales have been taken into account

• net profit margin - this is a much narrower measure of profits, as it takes all costs into account, not just direct ones - as well as interest and tax payments

• operating margin - this lies between the gross and net measures of profitability and overheads are taken into account, but interest and tax payments are not, so it is also known as the EBIT (earnings before interest and taxes) margin

• return on capital employed - this calculates net profit as a percentage of the total capital employed in a business, to see how well the money invested in your business is performing compared with other investments you could make with it, like putting it in the bank.

Whether profit margins indicate good performance for your business or not will depend on your size and sector, and whether you are selling products or providing a service, so it is helpful to know what is typical for your category of business.

Things to look out for include:

• low gross margin for your category - may mean your pricing is too low or you are paying too much for your products or raw materials

• sales increasing but profits falling - may mean you are spending too much to acquire new customers or you are increasing the wrong type of sales.

Cashflow

Having healthy sales and good profits does not mean your business will survive. You must have sufficient cash to pay your bills or you cannot continue trading, so it is vital to run regular cash flow forecasts. 

Remember to include your tax and VAT obligations and due dates, as sometimes this is forgotten and leads to businesses failing.

You need to monitor:

• how much cash you have in the bank

• invoices your customers have not yet paid 

• payments you are due to make.

Your “runway” is how long you have until you run out of cash which is calculated by dividing your cash by monthly expenses. This tells you how long you have to ensure customers pay outstanding invoices, make more sales or secure more funding.

Accounting ratios

Using accounting ratios to understand how financial measures relate to each other can be useful. For example:

• liquidity ratios - tell you about your ability to meet your short-term financial obligations and avoid cashflow issues

• efficiency ratios - indicate how well you are using your business assets

• financial leverage or gearing ratios - show how sustainable your exposure to long-term debt is.

Some accounting software will help you calculate these quickly and your accountant can provide advice on how to understand and apply them.

5. Customer measures

When you have established your top financial measures such as sales and profitability, you may want to dig deeper to understand the reason for changes and establish:

• what do I need to do to bring in more new customers?

• how do I encourage more customers to return or buy other products or services?

• how much is it costing to acquire each new customer and what are the most effective ways of doing this?

Customer volume and acquisition

The metrics to look at on a regular basis will often relate to customer volume and acquisition e.g.:

• total customers - the volume of individual customers the sales came from 

• average spend - how much each customer spends on average

• customer lifetime value - the estimated total revenue you achieve on average from a customer over your whole relationship 

• new vs returning customers - the volume of and total sales from new customers vs returning customers making repeat purchases

• cost per customer acquisition - how much it cost to gain each customer (e.g. in marketing spend or time spent converting)

• conversion rate - the percentage of completed sales versus another metric such as leads or website visitors, which is especially valuable when comparing different approaches.

Customer satisfaction and retention

It is expensive to acquire new customers, so being able to retain regular repeat customers and maximise the value of each sale is very important for most businesses to succeed. You will likely also want to track customer satisfaction and repeat purchase metrics including:

• net promoter score - measures customer satisfaction by asking users how likely they are to recommend your product/service and scoring your results between -100 and 100

• retention rate - the percentage of customers who continue buying or using your service

• churn rate - the percentage of customers who stop buying or subscribing.

Depending what these metrics indicate, you may seek more data to help you understand:

• which channels are most effective at bringing in new customers

• whether your website is working effectively

• what are your top selling products or services

• what issues lead to customer dissatisfaction

• if you compare favourably to competitors.

This will help to inform your next actions around marketing, use of digital channels and product/service offering.

For example, if you notice a low percentage of customers returning, you might regularly monitor other data such as customer complaints and online reviews and seek feedback to identify why customers are not making repeat purchases. Perhaps your product is wrong, poor quality, not as the customer expected or being delivered broken or late. Without fixing this, you will be wasting money acquiring new customers.

6. Operational and employee measures

Internal measures

It will be important to have some measures to ensure that internal processes, activities and outputs are high quality and delivered efficiently. These will vary significantly by business.

In service and consultancy businesses for example, timesheets can be used to understand what activities and customers take up the most staff hours and whether this is profitable for the business.

A manufacturer that produces and sells low-cost goods in high volumes might monitor and set targets for production line speed. Alternatively, a manufacturer that produces smaller quantities but uses high-cost components might focus instead on targets to reduce production line errors to minimise wastage.

In some cases it will be important to measure quality standards to secure new business or demonstrate regulatory compliance.

Staff measures

As the number of employees grows in a business it will be important to track if you are appropriately managing and supporting your staff. You may want to measure elements such as:

• employee retention
• satisfaction
• effectiveness of training
• individual and team performance
• attendance.

Our human resources section has a wealth of information on these areas.

7. Avoiding pitfalls

Vanity metrics

It can be tempting to set KPIs against everything, however it’s important that you keep your measurement focused on the metrics that truly impact your bottom line.

Avoid vanity metrics, which sound good (such as total website traffic, total social followers) but don’t actually give you real insight or lead to changes in strategy. It is fine to track these types of metrics when needed (e.g. if you are running social ads to increase your social following, then total followers becomes a key metric) but not as part of your overall business strategy.

As a general rule, if a metric wouldn’t change what you do next week, don’t track it.

Unintended consequences

While setting objectives and KPIs helps focus everyone on what needs to be done, sometimes there are unintended consequences if the focus becomes excessive. 

This can lead to:

• Tunnel vision. This is where staff are so focused on the target they miss opportunities or risks. For example if there is a target to develop new products then staff might not notice that adapting an existing one could be more cost-effective for the business. 

• Unethical or counterproductive actions. For example, if there is a target to send a certain number of marketing emails to customers, then staff may be tempted to let lower quality email promotions go out because they are so focused on achieving the number. If the aim is to answer new calls within a set time, then call handlers may cut short existing calls with customers and reduce satisfaction for the sake of a few seconds.

• Toxic internal competition. If teams become too competitive they risk undermining each other and creating a negative culture for the customers, for example squabbling over sales leads to reach a target. 

The whole business needs to work collaboratively to achieve the overall goal, so when setting targets, try to predict and then actively check for any unintended consequences.

Techniques such as using balanced scorecards or industry dashboards when choosing KPIs and setting targets can also build in a balanced approach to ensure performance is monitored from all key perspectives:

• financial

• customers

• internal processes

• staff.

8. Reviewing your business plan

Your performance should be used to inform regular reviews of your business plan and assessment of whether the overarching objectives and strategy are still right for the business.

Read more about working on your business plan.