What Are KPIs? Definition, Examples, and How to Use Them

What are KPIs? Key performance indicators are the small number of measures that show whether a business, a team or a project is on track toward its goals. The word that does the work is "key": a company may track hundreds of metrics, and only a few of them tell you whether you are succeeding and what to do next. A KPI has a definition, a target, an owner and a rhythm of review, and it is tied to a decision someone can make. This guide defines KPIs, lists the qualities of a good one, groups examples by type, builds a KPI tree with worked calculations for inventory turns, days of inventory and the cash conversion cycle, explains how to set targets and thresholds, and sets out how to review KPIs and avoid common errors. It belongs to business analytics for finance and operations, and it leads to 25 financial KPIs and KPI vs. metric. KPIs are an essential part of budgeting and forecasting.

A plain definition

A KPI is a quantifiable measure of performance against an objective that matters to the organization. Compare two statements. "We want to be a reliable supplier" is an aim. "On-time, in-full delivery of at least 95 percent of order lines" is a KPI: it can be measured, it has a target and it indicates whether the aim is being met. A KPI turns an intention into something a team can see, discuss and improve.

The qualities of a good KPI

If a measure fails these tests, it may still be useful as background information, but it should not be on the KPI list.

Types of KPI

Leading and lagging

Lagging KPIs report results after the fact: revenue, profit, churn. They are important because they measure what you care about, and they arrive too late to change the period just ended. Leading KPIs indicate what is likely to happen: pipeline value, orders on hand, website traffic, early product usage, supplier lead times. A good set contains both. See leading vs. lagging indicators.

A worked KPI tree

A KPI tree breaks a headline KPI into drivers that different teams can influence. Take working capital, which matters to an operations-heavy business. Three components make up the cash conversion cycle: days sales outstanding (DSO), days inventory outstanding (DIO) and days payables outstanding (DPO).

Hypothetical annual figures: cost of goods sold $1,200,000; average inventory $300,000; sales $1,500,000; average receivables $185,000; average payables $130,000.

• Inventory turns = COGS / average inventory = 1,200,000 / 300,000 = 4.0
• DIO = 365 / turns = 365 / 4.0 = 91.3 days (or average inventory / COGS × 365 = 300 / 1,200 × 365)
• DSO = receivables / sales × 365 = 185,000 / 1,500,000 × 365 = 45.0 days
• DPO = payables / COGS × 365 = 130,000 / 1,200,000 × 365 = 39.5 days
• Cash conversion cycle = DIO + DSO - DPO = 91.3 + 45.0 - 39.5 = 96.8 days

Each driver has an owner: operations or planning for inventory, finance or credit for receivables, procurement for payables. If the company improves inventory turns from 4.0 to 5.0, DIO falls to 73.0 days, and average inventory falls to 1,200,000 / 5.0 = $240,000, releasing $60,000 of cash. If DSO falls by five days, receivables fall by 5 × (1,500,000 / 365) = $20,548. The tree makes clear where effort pays, and who is accountable. See cash flow management.

Setting targets and thresholds

A KPI without a target is a statistic. Set targets from a mix of history (what we have done), plan (what the budget needs), benchmarks (what similar companies achieve, with care) and capability (what is realistic given resources). Express targets as a number and a date. Use thresholds to signal status: for example, green at or above 95 percent on-time delivery, amber from 90 to 95 and red below 90. Agree on thresholds in advance, so that status is not argued after the fact.

Review rhythm

In each review, spend time on the exceptions: the red and amber items, what is driving them and what is being done. Reviewing every KPI in detail every time wastes the meeting.

Common problems

• Too many KPIs. Attention spreads, and nothing improves.
• Measuring what is easy. Web visits instead of orders, hours worked instead of results.
• Perverse incentives. A target on speed of ticket closure encourages closing tickets without solving them. Pair KPIs, such as speed and customer satisfaction.
• No ownership. A KPI everyone watches and nobody owns does not move.
• Stale KPIs. What mattered last year may not matter now. Review the list yearly.
• Gaming. If a number is tied to rewards, check how it is calculated and audit it.
• Comparing without context. A fall in sales in a month with fewer working days is not a trend.

How many KPIs?

There is no magic number. A useful guideline is that a leadership team should be able to hold its top KPIs in mind: often between five and ten for the company, and three to five for a team. Anything beyond that probably contains metrics that should sit in supporting reports. See how to choose KPIs that drive decisions.

KPIs described in sentences

A KPI is easier to manage when it is written as a sentence that anyone can read. "Gross margin is revenue less cost of goods sold, divided by revenue, measured monthly, with a target of 38 percent." "On-time in-full is the share of order lines delivered complete on the promised date, measured weekly, with a target of 96 percent." "Customer acquisition cost is the sales and marketing cost of winning new customers in a month divided by the number of new customers, with a target below $25." Writing the KPI as a sentence forces the team to define the formula, the period and the target in one place. If you cannot write the sentence, you do not yet have a KPI.

A KPI in action

Suppose a company has 4,000 order lines a month and on-time in-full delivery is 91 percent, so 360 lines (4,000 × 0.09) arrive late or incomplete. Each failure costs about $35 in expediting, credits and customer service time. The monthly cost is 360 × 35 = $12,600. The KPI target is 96 percent, which would reduce failures to 160 lines (4,000 × 0.04), a cost of $5,600. The improvement, 200 fewer failures, is worth 200 × 35 = $7,000 a month, or $84,000 a year, and that figure is a useful guide to how much effort and spending on the improvement is justified. The KPI is not just a number on a page; it ties performance to money, and it tells the operations team where to look: root causes of failures by supplier, product and warehouse.

KPIs by department, in brief

Finance tracks margins, cash conversion, forecast accuracy and the time taken to close the books. Operations tracks on-time delivery, inventory turns, order cycle time and quality. Sales tracks pipeline coverage, win rate and average deal size. Marketing tracks customer acquisition cost, conversion and return on spend. Customer service tracks resolution time and satisfaction. People teams track turnover and time to hire. Each team should have a handful that ties to the company goals, and a view of how its KPIs affect the others. For a broader set of examples, see KPI examples by department.

The documents behind a KPI program

A working KPI program needs five simple documents: the list of KPIs with owners and targets, a definition card for each one, a data source map, a review calendar and a change log. Keeping them in one shared folder avoids confusion when people leave or priorities change. Publish them where everyone can see them, and update them when definitions change. When a KPI is redefined, restate history so that trends remain comparable.

Questions leaders often ask

How do KPIs relate to the budget? The budget sets financial targets for the year. KPIs track progress toward the budget and toward non-financial goals, and many KPIs are the drivers behind the budget lines, such as price, volume and margin.

Who should set the targets? The owner proposes them, the leadership team challenges them, and the final targets are agreed in the planning cycle. Targets imposed without discussion are less likely to be met.

What if a KPI is outside our control? Then it is a context metric, not a KPI for that team. Choose a driver the team can influence.

Should bonuses depend on KPIs? Linking pay to KPIs raises the stakes on the definition and the data, and increases the risk of gaming. If you do it, use several measures, audit the data and include balancing measures.

FAQs

What does KPI stand for?

Key performance indicator. It is a measure of progress toward an important objective.

What makes a good KPI?

It is linked to a goal, clearly defined, measurable, controllable, timely, comparable and owned by someone, and the list is short.

What are examples of KPIs?

Gross margin, cash conversion cycle, on-time in-full delivery, inventory turns, customer acquisition cost, repeat purchase rate and forecast accuracy.

How many KPIs should a company track?

Few enough to focus attention, often five to ten at company level and three to five per team, supported by detailed metrics when needed.

What is the difference between a KPI and a metric?

A metric is any measurement. A KPI is a metric that is tied to a key goal and used to manage performance. See KPI vs. metric.