Key Performance Indicators for Management Accounting
The decision to open an e-shop was a strategic move that will help this company to increase its sales, improve revenue generation, and manage market competition in a more effective way than when it only had brick-and-mortar shops. It is important to look at key performance indicators for management accounting to determine the benefits that this strategic move will have for the firm’s ability to increase its revenues.
Lautour (2018) defines key performance indicators as core metrics that a firm uses to monitor the progress it is making towards the realization of specific objectives. They help top executives to determine the value of the investment made and the effectiveness of new strategies embraced. As Škerlavaj, Černe, Dysvik, and Carlsen (2016) note, when a firm comes up with a new strategy in the market, the impact should be felt in terms of increased sales volume, reduced cost of operation, and an increase in profitability. In this chapter, various key performance indicators were considered important in improving the overall performance of the company. These indicators will be classified into two groups, as discussed below.
Growth Indicators
The market for construction materials and tools in Switzerland is highly competitive. The sustainability of a firm in such a competitive market depends on its ability to attract and retain a pool of loyal customers. Growth indicators help in determining if the firm’s customer base is growing through improved sales and profitability. The following indicators are critical from the management accounting point of view:
Sales growth
Sales growth is one of the most important key performance indicators that will be of interest in this firm after going online. From the perspective of management accounting, Lautour (2018) defines sales growth as the measure of effectiveness and trends. The indicator helps to determine the direct benefits of a new approach of operation in terms of sales generated. When calculating sales growth, (Current period sales – last period sales)/last period sales) x 100 is often the formula used (Parmenter, 2016).
The goal of the accounting manager is to compare the change in sales volume before and after the introduction of the new system. The expectation of the management unit of this firm would be that after introducing the e-shop, there would be a consistent increase in the overall sales volume. The increase in the number of building materials and tools sold will have a positive impact on the firm’s growth in the market.
E-market has gained popularity in developed nations and emerging economies of Asia and parts of Africa. The growing size of the middle class who has to work for the better part of the day has led to an increase in the popularity of e-marketplace (Charifzadeh & Taschner, 2017). They lack time to visit brick-and-mortar stores, which may be located several miles away from the office or home. Technological advancement has made it possible for these buyers to purchase their products without having to leave their offices or homes.
They only need to visit relevant websites, compare prices, and then make an order based on the best deals available. The brick-and-mortar business model is restrictive to both the customer and the company. The shop must be closed at a specific time to allow employees to go home and rest before resuming work the following day.
When the management of a firm establishes that it is not economically viable to operate at night because of the high amount of wages that have to be paid, a firm will only be forced to operate in the daytime. However, such concerns are often eliminated when a firm has an e-shop. Customers can visit the firm’s website at any time and make an appropriate payment without having to worry about time (Schwarzbichler, Steiner, & Turnheim, 2018).
There would be an overall increase in sales because of the extended time within which the firm operates. Expenses that the firm has to incur when operating for 24 hours a day in an online market is negligible compared with what it would have to pay in a brick-and-mortar business model. From the management accounting point of view, it will be of interest to have a precise calculation of changes in the overall sales of the company’s products within a given period, probably one year, to determine if it was worth investing in the new approach.
Close rate
Close rate is another critical performance indicator that the management can use to determine if it is making appropriate progress in the market through the new online-based strategy. According to Kaiser and Young (2013), a close rate refers to the effectiveness of converting leads into sales. When a firm is selling construction materials and tools, a significant portion of clients tends to be organizations. Using leads may help in converting potential buyers into loyal customers.
In a brick-and-mortar business model, it is not easy to statistically determine how leads are converted into sales. However, it can be done easily using special software when handling online clients. A firm is able to track how various optimization tools it is using are increasing the rate of online traffic onto its website. Once a client visits the website, the firm can easily determine their behavior in terms of products they view, their preferences in terms of quality and cost, and the time they spend on the website. The software will trace activities until the time a client decides to make a purchase or visit other websites of firms offering similar products.
A close rate is often used to determine if strategies that a firm is using are effective. Its formula is (Number of sales)/ (Number of selling opportunities) (Kaiser & Young, 2013). This firm will be able to determine how every opportunity to sell its construction materials and tools are converted into actual sales. The indicator can help identify an underlying problem within the firm. If it is established that most of the opportunities are lost, then the management will be interested in explaining why that is the case. Using online customer tracking tools such as Google Analytics, Clicktale, Clicky, and CrazyEgg, a firm can determine the number of customers visiting its e-shop but end up purchasing similar products on another website.
Understanding why such opportunities are lost helps in determining the weaknesses of the firm that need to be addressed. On the other hand, a high close rate is an indication that the firm is doing the right thing in the e-market. It is often reflected in the sales growth of the firm.
The accounting department may need to work closely with the marketing unit of the firm to enhance the firm’s close rate. The accounting department will provide statistical information about the close rate. The marketing unit can use the information to identify internal strengths and weaknesses and develop a plan to take advantage of opportunities while at the same time taking care of threats.
Net profit
Net profit is another key performance indicator that is important from the management accounting point of view. In fact, it is always the primary goal of every firm whenever it comes to a new strategy. Parmenter (2016) defines it as the measure of profitability or profit obtained by subtracting all expenses from the total revenue within a given period, preferably in a year. When this company decided to open up an e-shop to increase the sale of building materials and tools, the ultimate goal was to increase its net profit.
An increase in net profit has a direct positive impact on the financial capacity of a firm. The additional revenues make it possible for the firm to expand its operations, improve the quality of the workforce through training and to hire the best talents, and to engage in research with the aim of improving product quality and market share. It is in the interest of all departments within the firm, including the accounting unit, to ensure that there is a consistent increase in annual net profit to help generate more income.
When calculating the net profit of a firm, the appropriate formula is (Sales – Cost of Goods Sold – All other expenses)/ Sales (Lautour, 2018). It is important to note that a profit is calculated only from the sales of goods and services of a firm. It does not include additional capital injected by the owner of the business, loans, and grants, or any other source that does not involve the sale of a firm’s products. Sousa and Effy (2014) warn that although it is important for a firm to ensure that its net profit increases annually, it should not be achieved in a manner that compromises customers’ loyalty.
Warning Indicators
Warning indicators are crucial to the management of this company as it introduces the new e-shop because they identify major weaknesses that need urgent attention of the management. The management of this firm should ensure that it takes advantage of the new e-shop to avoid negative trends of these indicators. The following key indicators should be monitored closely to ensure that the company remains operational:
Debt-to-equity
This performance indicator focuses on determining the proportion of debt and equity that a firm uses to finance its assets (Cokins, 2013). It is normal for a firm to purchase its assets through debt. However, Sousa and Effy (2014) believe that it is dangerous to have a situation where most of the assets are financed through debt. The amount of money borrowed to purchase such assets should be payable within the period that they are due.
When using this indicator to calculate a firm’s financial leverage, the appropriate formula is (Total liabilities)/ (shareholder equity). When the ratio is high, it is a sign that most of the resources of a firm are financed through external borrowing. Lautour (2018) explains that one of the threats of having large amounts of debts is that it may not be easy to pay them back within the right time while at the same time meeting other financial obligations.
Employees or shareholders may have a wrong perception that the firm has many assets, and as such, should increase their rewards, failing to understand the other financial responsibilities of the firm to its debtors. As such, it is advisable to ensure that the ratio is maintained at a level that may not exert financial strain on the firm. The inability of the firm to pay its debts may force it to declare bankruptcy, a situation that every firm would try to avoid.
Current ratio
One of the most commonly used key performance indicators in management accounting is the current ration. Charifzadeh and Taschner (2017) state that it as the ability of a firm to pay its short-term liabilities using short-term assets. These debts need to be paid within a short period, such as within the next thirty days. They may include monies to be paid after the delivery of supplies has been made, salaries, and loans that are due.
These debts should be paid using cash in the bank, cash at hand, or proceeds from the sale of assets that a firm has. When calculating the current ration, the standard formula (Current Assets)/ (Current Liabilities) (Cokins, 2013) should be used. It is considered a warning indicator because the inability of a firm to pay current debts when they are due may paralyze its operations. The strategy to open a new e-shop is expected to increase the firm’s current ration.
The fact that clients will have a longer time than before to purchase products they need will increase sales. E-shops also eliminate geographic barriers (Cokins, 2013). It makes it possible for a firm to have a wider geographic area to cover because most of the orders are placed through its website. The strategy also reduces the need to rent physical stores and hire shop attenders. As sales increase, expenses that the firm has to incur will reduce.
Working capital
Working capital is another important performance indicator that is of great interest in management accounting. It refers to the operating liquidity of a firm or the asset that a business uses in its daily operations (Cokins, 2013). It defines the ability of an organization to meet its daily financial obligations. The working capital may vary a lot from one time to another, depending on various factors. When the day’s sales are high and expenses are low, the working capital may be high, and vice versa.
When calculating this metric, the appropriate formula is (Current Assets –Current Liabilities). When a negative value is obtained in this calculation, it is a sign that the firm is insolvent. The insolvency may have serious implications on a firm, especially when the firm lacks the needed cash to finance its daily operations. It may lead to temporary suspension of critical activities as the firm seeks financial support. The decision to embrace online sales of products may be a solution to avoid such undesirable situations within a firm. It is expected that the e-shop will increase sales, which in turn will increase the amount of cash available for the firm to fund its short-term operations.
Customer Service
The two categories of performance indicators are directly influenced with the customer service approach that a firm embraces. Although this indictor is popular among marketers, in this context it will be useful from the management accounting point of view. The goal of the new strategy (e-shop) is to increase sales, which will translate into increased revenues, increased profits, and an attractive balance sheet.
However, such goals cannot be achieved if the firm lacks a proper customer care service. Operating in an online market does not mean the firm does not need to have an effective customer service, as Lautour (2018) observes. Clients may need to call and confirm their purchase before making payments. They may need clarifications especially given the fact that they are not physically present at the store. It means that the firm’s customer care service should be better than it was when it was operating offline.
The firm should ensure that it has a team of experts who understand the nature of construction materials and tools sold at the firm working at its call centers. They need the knowledge to ensure that they can receive clients’ calls and answer their questions in the most satisfactory way possible. The call center should remain operational 24 hours a day, each day a year to avoid cases where customers fail to get services needed.
Prompt delivery of products once customers make payment is part of customer service. Charifzadeh and Taschner (2017) also note that a firm should ensure that it delivers on its promise. The item that a customer purchases on the website should be the exact one delivered to them in terms of quality and quantity. It improves trust between the client and the firm. The most appropriate indicator that the firm’s customer service is effective would be an increase in repeat purchases. Some customers may not express their satisfaction in words. However, their decision to make additional purchases from the firm would be an indication that their needs were met.
References
Charifzadeh, M., & Taschner, A. (2017). Management accounting and control: Tools and concepts in a central European context. Hoboken, NJ: Weinheim Wiley-VCH.
Cokins, G. (2013). Strategic business management: From planning to performance. New York, NY: American Institute of Certified Public Accountants.
Kaiser, K., & Young, S. D. (2013). The blue line imperative: What managing for value really means. Chichester, UK: John Wiley and Sons.
Lautour, V. J. (2018). Strategic management accounting: Volume II. Cham, Switzerland: Palgrave Macmillan.
Parmenter, D. (2016). The financial controller and CFO’s toolkit: Lean practices to transform your finance team. Hoboken, N.J: John Wiley & Sons.
Schwarzbichler, M., Steiner, C., & Turnheim, D. (2018). Financial steering: Valuation, KPI management and the interaction with IFRS. New York, NY: Springer International Publishing AG.
Škerlavaj, M., Černe, M., Dysvik, A., & Carlsen, A. (Eds.). (2016). Capitalizing on creativity at work: Fostering the implementation of creative ideas in organizations. Northampton, MA: Edward Elgar Publishing.
Sousa, K. J., & Effy, O. (2014). Management information systems (7th ed.). London, UK: Cengage Learning.