Key Performance Indicators and Causal Relationships

This past week, we met with a client to help them determine what their key performance indicators are in order for them to drive profitable growth. While some think this process is quite straight forward, we still continue to find individuals who do not understand the importance of causality and processes when developing the right KPI’s for their business.

Don’t get us wrong. We still insist that our clients (many who have finance and accounting backgrounds), to continue to read their monthly financial statements, including the traditional Income Statement, balance sheet and cash flows and to continue to compare those monthly results to the plan and/or to the previous year’s results. We also continue to encourage them to run the traditional ratios as a way to check the health of their business.

What we are recommending is that they create a new section within this review that includes more significant key performance indicators as part of their management process to track and predict their business success.

This section must, however, be carefully crafted to ensure that the ‘right indicators’ are included that properly measure the processes the business engages in every day. Let us explain.

While we won’t get into the academic discussions pertaining to Causality (you can google Causality or go to Wikipedia to get into the details of the subject from multiple disciplines), the key idea is that with any business process, there are certain ‘laws’ governing that process. While everyone may not totally understand the ‘laws’ governing that process, those ‘laws’ still ‘govern’ that process. Those laws must be followed in some order to get the desired outcome. Any deviation from those laws will result in a less than desireable outcome. Let us give a simple example.

For instance, the process of baking a cake (i.e. the recipe) is pretty straight forward. However, understanding the right amount of ingredients and in what order to mix them in in order to get the desired taste and appearance is required (i.e. understanding the laws governing that process).

The same ideas applies to creating the right KPI’s. You must not only understand your process but also understand what events or actions cause certain results within the business (i.e. the laws). You must then ensure that you choose the right measure to tell you if that law is being followed or not (we won’t get into the issue of the law no longer being valid). By then creating and calibrating measures to monitor your key ‘laws’, you can then predict how and where your business will go. (thus the concept of a key performance indicator).

Above all though, you must ensure that your KPI truly measures the laws and causal relationships within your business (i.e. the baking a cake example.)

Our clients have found that once they have completed the above efforts to develop their KPI’s, they have been able to troubleshoot faster since they can quickly and easily identify where the problem lies. In turn, they have then been able to solve those issues quickly. In fact, they have found that they have moved from a reactionary state to one where they are proactivly managing and growing their business.

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