Meaning of Key Performance Indicator (KPI) and its function

Key Performance Indicator – Management and evaluation are important functions that enable the organization’s work plan to be implemented well so that the organization’s ultimate goals can be achieved. A good performance management system is required for proper control and evaluation functions. A good performance management system should be able to describe business processes that take place throughout the organization.

This performance management system can also be measured by using Key Performance Indicators (KPI), so it can also be a good measure of success. The performance management system contains KPIs or key performance indicators that represent the performance of all parts of the organization and the relationship between those parts.

Many companies already have a performance management system, but only provide a “KPI list” and ignore the relationship between metrics.

During the last few decades, performance management systems such as the Balanced Score Card (BSC) have been developed to explain the relationship between indicators. In BSC, the relationship between indicators is only expressed qualitatively.

If this relationship can be expressed quantitatively, force measurement models can be used for clearer and more specific purposes. Such as, more specific improvement efforts or prediction of system operation in the future.

Meaning of Key Performance Indicators

Key Performance Indicator (KPI) is a measurement tool that describes the effectiveness of a company in achieving business goals. Simply put, Key Performance Indicator is a term used to refer to key performance indicators that need to be applied by various organizations.

Companies that use KPIs aim to measure their success in achieving their goals. In its application, KPI has characteristics that can be seen as follows:

  • Measurements that are often used (Regular measurements)
  • Non-financial measure
  • Measures known by management
  • All parties in the organization already understand and understand the KPI
  • Responsible for teams and individuals
  • Has a very significant and comprehensive effect
  • Has a more positive effect

Key performance indicators are measured during daily, weekly, and monthly periods. A good KPI is important and continues to attract the attention of management. If someone deviates from the KPI, management can take a decision and call the person responsible.

The meaning of Key Performance Indicator has been defined by experts, as follows.

  1. Iveta (2012): KPI is a quantitative and step-by-step indicator from a company with a different perspective and is based on concrete data formulated as a starting point for setting goals with organizational strategy.
  2. Warren (2011): KPI is an indicator of how an organization implements its strategic vision. The strategic vision referred to refers to how the organization’s strategy is interactively integrated with the organization’s overall strategy.
  3. Parmenter (2007): defines KPI as the most important thing for the success of the organization in current and future conditions.
  4. Banerjee and Biotik (2012): KPIs are measurable, quantitative indicators used to evaluate the performance of organizations to achieve their goals. KPIs are also used to identify measurable objectives, and refer to support for trends and results.

In a broad sense, Key Performance Indicator can be defined as a useful decision-making tool because it helps organizations or companies measure individual performance and evaluate the performance of the organization itself to achieve its goals with the reach of the strategic vision.

The term KPI is generally used in a business context, so not everyone understands the meaning of the name. The main performance indicator, abbreviated as KPI in English, is an important indicator (key) to confirm the progress of the desired results. This performance indicator can be measured daily, weekly, monthly so that it can be considered by management.

 

Types of Key Performance Indicators

Based on the definition of  Key Performance Indicator above, in practice the company has 2 types of KPI that can be used, as follows.

1. Financial KPIs

Financial KPI is the most important form of performance indicator related to all things related to finance. An example of this financial KPI is as follows.

  • Gross profit KPI, KPI that measures the amount of money left over from income after deducting cost of sales (CSP).
  • Net Profit KPI, a KPI that measures the amount of residual income after deducting the selling price and other operational costs such as interest and tax burden.
  • Gross profit margin KPI, a KPI that measures the percentage value obtained by dividing gross profit by sales.
  • Net Profit Margin KPI, a KPI that measures the percentage value obtained by dividing net profit based on revenue.
  • Current Ratio KPI, a KPI that measures financial performance from the cash balance by dividing current assets by current liabilities.
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This indicator estimates how well the company will survive in the event of a sudden recession.

2. Non-Financial Key Performance Indicators

Non-Financial KPI is a type of KPI whose form does not directly affect the finances of a company. Examples of Non-Financial KPIs that companies usually have are as follows:

  • Manpower Turnover about Workforce Rotation
  • Customer Satisfaction metrics about the Customer Satisfaction Matrix
  • Repeat Customer to New Customer Ratio about Repeat Customer to New Customer Ratio
  • Market Share about Market Share

 

Reasons Why Key Performance Indicators are important for Organizations

KPIs are an important part of measuring performance and failure. KPI is also called flash or dashboard, and KPI provides entrepreneurs and administrators to get a general explanation of the actual development of the company (in a certain time). KPI measures business objectives of actual data and measured data in a specific time period.

Here are the reasons why companies need to apply KPI because it has several benefits as follows:

1. Targets Become More Measurable If Using KPIs

When using KPI, this element will be a tool to measure the range that approaches the goal. KPI is not a goal or target. For example, KPIs can show that the current team can only reach 20 percent of the desired prospects (depending on the benchmarks set by the company, of course).

Based on the information displayed by the KPI, the sales manager can determine the sales progress and why the reported results are not as expected. This will allow managers to make new strategies in the future.

2. Creating a Learning Atmosphere

The data generated by KPIs will prompt employees to create important conversations between their teammates and administrators. When used as a habit, then a learning environment will be created in the company. It is also possible to analyze if the KPI is effective, or if the KPI is reasonable enough to achieve the team.

3. Get important information 

KPIs offer a direct description of the company’s performance as a whole. The real time data shown by the KPI allows the company to adjust systematically so that the company does not need to make large-scale changes at the end of the month to achieve the target so that it is more energy efficient.

In addition to obtaining an overview of the level of performance in the work environment, some companies that use KPIs can measure how well they are achieving certain standards that may not be directly related to the business or profits of the company exactly.

4. Supporting Corporate Accountability

If there is no accurate and measurable data source as provided by KPI, the company will experience difficulties when giving employee performance evaluations. Companies can assume that their employees are performing poorly because they are hampered by involvement problems.

However, they do not have evidence that they can measure. Even if the company can measure the performance of other statistics, KPI may be the most important tool. Basically, KPI promotes employee accountability (accountability) (if they are lacking in their performance) and the company (if it is difficult for KPI to achieve).

5. Can Increase Spirit

KPIs are very useful, and employees can make employees get positive feedback because employees meet certain KPIs. The results are often quick and this creates a feeling of “having a purpose” and being able to achieve this purpose.

 

Factors That Influence Key Performance Indicators

KPIs are only useful if the company has a track record of the KPIs themselves. Companies often adopt KPIs that are commonly used in the industry. But then he wondered why the KPI did not reflect the company’s performance.

When developing a strategy to set KPIs, the team should start by ascertaining the company’s goals, the plan to achieve them, and who can take action based on that information.

This should be an iterative process that includes input from analysts, department heads, and managers. Enterprises will then gain a better understanding of how KPIs can measure enterprise business processes and who can track them.

One way to create relevant KPIs is to use SMART criteria. This term means concrete, measurable, achievable, relevant, and time-bound.

The explanation of this KPI factor can be summarized in the following question.

  • What is the purpose of the company specifically?
  • Can the company measure the achievement of these goals?
  • Is this goal achievable?
  • Will this purpose be relevant to the enterprise?
  • How long will it take to achieve this goal?
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How to Set Key Performance Indicators

There are four basic criteria that must be met before an organization declares that it has implemented KPI in its operational activities. The criteria are as follows.

  • Cooperation between employees, teams, suppliers, and customers
  • Decentralization from the management level to the operational level
  • Integration or relationship between actions, reports, and actions
  • Relationship between KPI and Implementation Strategy

KPIs require interrelated system processes both from the organization itself, such as employees, managers and shareholders, as well as external parties such as customers and suppliers. Similarly, reports should be timely and efficient and focused on improving decision-making.

When implementing KPIs, it is important to define the outcome or purpose of each KPI. When applying KPIs, there is a way to plan goals that combine several criteria called SMART (concrete, measurable, achievable, realistic, time-sensitive).

Here is an explanation of the acronym SMART.

  • Specific is that goals or results should be clear and specific, without general goals or expected results. When a goal or result is clear and specific, it is very easy to know when that goal/result is achieved.
  • Measurable means a goal or result that must be measured both in quality and quantity. This can be set in relation to standard performance or performance expectations.
  • Achievable means that it can be achieved, but it needs to be stated as a challenge, so as to encourage the organization to achieve its results or goals.
  • Realistic is creating ideas that must be realistic and result-oriented, as well as achieve results or goals.
  • Time Sensitive is that every result or goal has a time limit on how long it can be achieved. The fact that a goal or result requires a time limit makes it easier to measure the improvement of the next goal or result.

Developing KPIs takes time and resources for companies. The main performance indicators that are measured are indicators that meet the company’s needs, taking into account the company’s short-term strategy and goals.

 

Tips for Applying Key Performance Indicators

Here are some tips for applying Key Performance Indicators .

1. Have a Clear Purpose

Key performance indicators have clear guidelines that anyone who reads or calculates must be able to interpret the data correctly. If the business objective of your organization or company is to be a “market leader”, then the KPI objective is “increase sales by 10%” or “product marketing in Southeast Asia”.

You can arrange how to “expand the scope”. The purpose of the KPI must be clear and strategic. Strategic relationship is how to evaluate how the organization does the strategies and measurements that should be achieved, how the organization can evaluate the vision and mission they have.

2. Create a goal that achieves the outline

What is your purpose? Can you achieve it? When do you need to achieve that goal? How can you measure the progress of the applied strategy? What strategies are used to affect the finances of the organization or company?

Targets must be realistic and business process changes take time to be implemented. In the early stages of KPI monitoring, it is best to focus on long-term goals and medium-term monitoring.

3. Data Collection

KPI is a quantitative measurement. Therefore, specific and valid data is needed to determine the main performance indicators. This helps to accurately and accurately measure the indicator.

4. Review Changes to Date

The reason KPI reviews are so helpful. Let’s say the company exceeds the targeted results, for example the target of 120 percent, and still has good productivity, then it is not wrong to try to make it the next goal in order to increase results.

Instead, if it is not achieved, do not force the next goal to improve the next goal to influence the motivation and productivity of the team. In other words, the company needs to be aware of whether there is a deactivation for the team’s performance.

5. Formulating KPIs

Some KPIs contain only one metric or measure. However, in most cases it depends on the combination included in the formula.

For example, the KPI that measures income productivity from product sales is total income divided by the total number of products. Create an appropriate expression and keep testing the expression to see if the results the company gets match your realization.

6. Presentation of KPIs

To deliver key performance indicators efficiently, data must be transformed into easy-to-understand visual representations such as graphics and charts. Provide instructions to all employees about the KPI calculation process to achieve an effective and goal-oriented work pattern.

Well, that’s the explanation about the Key Performance Indicator (KPI) or the main performance indicator that needs to be implemented by the company.