UK: Savvy Managers Look To The Future To Get The Perspective They Need To Influence Performance

Last Updated: 3 September 2013
Article by Deloitte LLP

Most Read Contributor in UK, August 2017

How using business operations metrics as leading indicators can provide better financial forecasts

As part of their performance management process, companies often rely heavily on historical information, or lagging indicators, to make decisions. Why? Because this information is clear-cut, readily available in information systems, and consistent with external reporting requirements.

But how can you see where you are going if you are always looking backwards?

Senior decision makers would actually be better served by using information on current operations—information that drives, or can be correlated with, future performance -  or 'leading indicators', that can provide greater insight into future performance and allow for more timely decision making.

Why leading indicators?

Managers constantly make decisions to better the performance of their businesses. Many of these decisions involve making investment or resource commitments designed to drive improved, long-term performance, and, for these, managers often rely on historical financial data.  

Using this historical data to make forward-looking plans has its limitations and over a given time - such as quarterly revenues or net profit - cannot be used to predict future performance. The real challenge for managers is to identify those operational events that can.

Leading indicators for a business enterprise include both qualitative metrics, such as customer satisfaction, product quality, and employee development, as well as certain key quantitative metrics, such as orders placed or sales forecast. Both types of leading indicators are essential and can help management make better decisions in a timelier manner.

Identifying and developing leading indicators

While the concept of leading indicators – such as customer satisfaction as a driver of repeat business - is easy enough to grasp, however efforts to "peel the onion" on leading indicator drivers within an enterprise often can produce confusion, analysis paralysis, and delay.

So, identifying leading indicators should be viewed as both a science and an art. The "science" aspect is measuring events that have a close correlation with the activity being measured. The "art" of identifying leading indicators is to know when to stop "peeling the onion."

Steps 1 - Define future performance to forecast

  • Identify Financial goals - determine the set of financial goals that drive shareholder value
  • Identify top-level contributing activities - Break down each financial goal into the top-level set of contributing factors

Step 2 - Identify drivers of performance

  • Define universe of drivers - To better understand the most meaningful drivers of performance, begin by identifying the list of potential drivers that could contribute to performance.
  • Identify measures for drivers - To make effective use of drivers, they must be measurable, so identify the most appropriate measure for each driver.
  • Analyse the correlation between the driver and performance to forecast - By definition, drivers have different cause-and-effect relationships with the performance to be forecast. Those with the strongest correlation are the most effective leading indicators of future performance. 

Step 3 - Put leading indicators to work

  • Formalise reporting of leading indicators - In order to capture their long-term benefits, leading indicators should be incorporated into standard reports and dashboards that are regularly evaluated by operational management.
  • Incorporate into other performance management processes – Leading indicators can provide additional insight when fully incorporated into performance management processes, including strategic planning, annual budgeting, forecasting, and analysis.
  • Incorporate into investment evaluation processes - Further benefit can be gained by incorporating leading indicators and drivers into business cases for investment. By definition, leading indicators have a strong relationship to shareholder value and allow for more effective quantification of investments.

Providing a future direction for the organisation

Incorporating the use of leading indicators can significantly improve management's ability to direct the future course of the company. The key is developing quality metrics that are rooted in business drivers correlated with financial performance to use as the indicators and to engage all business unit managers in the process.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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