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Leading and lagging indicators can help you measure business performance more clearly. Used properly, they give you a better understanding of what has already happened and what could be coming next.
The terms leading indicator and lagging indicator are often used when measuring performance. The difference between the two, and more importantly what to measure and how to measure KPIs, can sometimes be difficult to pin down.
A leading KPI is a measurable factor that changes before a business starts to follow a particular pattern or trend. Leading KPIs are used to predict change before it happens.
The downside is that they can suggest what might happen, but not what will definitely happen.
People tend to like leading indicators because they are varied, interesting and often not that hard to succeed at. That is also where the risk lies.
Just because a leading KPI is positive, it does not mean the final outcome will be positive. For example, you might have a lot of new visitors to your ecommerce website, but if they are not buying anything, the result is still poor.
A lagging KPI is a measurable fact that records the actual performance of an organisation.
Lagging indicators tell you what has already happened. Common examples include turnover, profit and revenue growth. They are usually easy to identify, measure and compare with others in your industry, which makes them very useful.
However, the obvious downside of backward-looking indicators is that they may provide insight too late for you to do much about it. By the time you find that turnover has dropped by 25 per cent, the damage has already been done.
Another downside is that lagging indicators can encourage a focus on outputs, meaning a number-based measure of what has happened, rather than outcomes, meaning what we actually wanted to achieve.
A good example of this will be familiar to anyone who regularly travels by train in the UK. As a lagging indicator, the train operator measures how many trains arrive at their final destination on time. To hit this target, the operator may amend the service and skip smaller stations along the route so the train arrives on time at the final stop. This may improve the KPI, but it can damage other measures that are arguably more important, such as customer satisfaction.
This focus on hitting lagging indicators, and how easy it can sometimes be to manipulate performance against them, means they are often prioritised over leading indicators, even when the leading indicators would be more useful in understanding and improving performance.
These all represent facts about the business.
Some KPIs can act as both leading and lagging indicators. These are especially useful because they can tell you something about historic performance while also showing whether the business may be heading in the right direction.
Researchers believe there is a strong correlation between customer satisfaction and growth in turnover. The theory is that happy customers become advocates, and advocates recommend you to other potential clients. Satisfied customers are also less likely to leave.
We covered this in a recent blog of ours, but measuring the working capital cycle shows how long cash flow is tied up, which is a lagging measure. At the same time, improvements in the working capital cycle can make growth easier and can also improve cash flow and often profitability.
For example
It is fair to suggest that happy employees can have a positive impact on the business and its performance.
It is easy to produce a long list of KPIs, but choosing the right mix is what really matters. We would usually recommend starting with one to three KPIs under each of the following headings
KPIs must be simple to measure. If they cannot be measured easily and accurately, it is usually better to move on to something else.
Equally, measuring three or four KPIs that are highly impactful and easy to track is often far more useful than trying to measure too much.
KPIs should not be hidden from your team, or even from customers if that suits your business and sector. If team members understand the KPIs and how they link to individual performance, you are more likely to get everyone moving in the same direction. It also creates the opportunity for useful ideas to come from within the team.
Finally, KPIs must be meaningful to business performance. If success against a KPI does not really affect the performance of the business, it probably does not need to be measured.
At The Advisory Group, we help business owners understand the numbers that really matter.
Choosing the right KPIs, and knowing how to use leading and lagging indicators properly, can give you a clearer picture of performance and help you make better decisions with confidence.
For more guidance on setting meaningful KPIs for your business, please get in touch here.
This publication has been prepared by The Advisory Group UK Limited and is not intended to be a comprehensive statement of law or represent specific advice. No liability is accepted for the opinions it contains. All rights reserved.