We've been compiling a whole bunch of KPIs across industries and departments as part of our KPI examples mini-series. This post is a small supplement to that series, which answers one of the most common questions we get asked when people first start creating their key performance indicators - What are leading and lagging KPI's, and what's the difference?
If you need to create your own KPIs, we've put together a guide with an easy 4 step formula to creating your own awesome KPIs.
For each KPI example in our mini-series, we've provided a brief description of why you might want to use it. We recommend that you create at least 2 KPIs for each of your key business objectives.
Tom has done an excellent job of sharing all sorts of KPI’s to help manage your business, but I wanted to spend some time focusing on leading and lagging KPI's, and how they can help tell your story.
Before joining the team here at Cascade, I was a CFO. From that experience, I can tell you first-hand that reading historical financial statements was the equivalent of watching paint dry for many on our senior team. Instant narcolepsy would take hold for ⅓ of the senior staff with the first PowerPoint slide sharing the balance sheet and income statement. A 3rd cup of coffee and a trip to the bathroom would be required to get through the actual to budget comparisons.
If you want to impress (or wake up) your executive team, start a discussion regarding leading and lagging KPI's.
Let's Start With Some Definitions of Leading and Lagging KPI's:
A leading KPI indicator is a measurable factor that changes before the company starts to follow a particular pattern or trend. Leading KPI's are used to predict changes in the company, but they are not always accurate.
Examples of Leading KPI's for a company’s future growth:
- % Growth in Sales Pipeline
- % Growth in New Markets
- Number of New Patents
- The Number of New Website Trials
- Number of Unique Website Views
People tend to love leading indicators because they're varied, interesting, and...often not that hard to 'succeed' at. But therein lays their danger...
Just because a leading KPI is positive, it does not mean the final outcome will be positive. For example, Sales Pipeline for a company is a leading indicator of sales. If the Sales Pipeline is growing it may indicate that the Company Sales will grow, however, if the Company does not convert the Sales Pipeline to Sales, the leading indicator may be inaccurate.
A lagging KPI is a measurable fact that records the actual performance of an organization.
Lagging indicators include the following:
- Annual Sales
- Growth in Annual Sales
- Gross Margin
- Annual Net Income
- Growth in Annual Net Income
These all represent facts about the company or organization.
Is 12-month trailing revenue at mid-year, a leading or lagging KPI indicator?
Answer: 12-months trailing revenue is a leading indicator.
The trailing 12-month revenue is the best predictor of what the full year will be. As each new year of monthly revenue records over a prior-year month, the new data points are a leading indicator of what the next year will be.
2016 Sales: $20 Million
12 Month Trailing Sales, as of June 30, 2017: $24 Million
In this example, it would be reasonable to predict that if July 1st 2017 through December 31, 2017 sales were flat year over year, 2017 sales would equal $24 Million and the company would expect to grow 20%.
Let’s take a few more examples from Liquidity Measures provided in the examples of KPIs for finance teams:
This measure is generally used by financial institutions to validate what is the ability for a company to meets its current obligations. Although this may be predictive in nature at one point of time, it is generally a lagging indicator at the end of a financial period.
This is also one of the lagging KPI indicators as it has described how often AR turns over for any specific period.
Runway and Burn Rate:
Burn rate is a lagging indicator as it describes how many money is spent (or lost) for any period of time. The runway is a leading indicator as it predicts how long cash would last with a specific burn rate.
A great example of the impact of leading and lagging KPI's is when a company does an Earnings Conference Call. If a company has great financial earnings and beats expectations, a company’s share price may increase because they have to increase their financial model to reflect the higher financial earnings. However, if the same company predicts lower future earnings, this leading indicator can significantly decrease a company's share price based on the lower expectations.
As you evaluate leading and lagging KPI's, ask yourself the question - is this predictive in nature and does it have a possibility of predicting the future? Valuable KPI’s have the closest correlation to predicting the future. Great organizations then should find the specific levers to improve those KPI’s which will in turn improve the company’s financial performance.
The bottom line is that you need to understand the difference between leading and lagging KPI's to ensure that you have a healthy mix when it comes to measuring your focus areas.