Non-Financial Performance Indicators: Choosing, Measuring and Interpreting Them

A courier company in Lagos has just had its best financial year. Revenue is up, margins are up, and the board is pleased. But the customer service manager reports that complaints have doubled, late deliveries are rising and the best drivers are leaving. In twelve months the profit figures will start to fall, and nobody looking only at the accounts will understand why.

Financial results are the outcome of earlier decisions and actions; the things that cause them, such as customer satisfaction, quality, staff morale and delivery performance, show up first in non-financial measures.

This topic explains non-financial performance indicators (NFPIs): why they are needed, how they differ from financial indicators, how to choose them (from objectives to critical aspects of performance to targets), the usual areas (human resources, customers, quality), examples by department and by industry, how to analyse and interpret them, and benchmarking. It builds on the earlier topic on liquidity, solvency and efficiency ratios. The next topic covers short-termism and financial manipulation of results.

Why non-financial indicators are needed

Financial performance alone does not give a complete picture. It is the result of underlying factors: the loyalty of customers, the quality of the product, the skills and morale of staff, the speed of delivery and the ability to innovate. These determine the profit a company will make in the longer term, so targets must be set for them and actual performance measured against them.

Financial indicators are quantitative; non-financial indicators may be either quantitative (a rate of returns, hours of training) or qualitative (an assessment of whether customer satisfaction is improving). Where possible quantitative measures are preferred because comparison is easier.

Differences from financial measures

• Variety. A limited number of financial ratios are used by almost all businesses. NFPIs vary: the key measures for a chemical manufacturer differ from those of a bus company, and two companies in the same industry may use different ones, because they follow different business models or objectives.
• Time scale. Financial targets are usually set for the budget year. NFPI targets need not be annual and may be longer or shorter. But if staff bonuses depend on them, there is a tendency to set annual targets to fit the budget cycle.
• Cause, not result. They often lead financial results, so give early warning.

How to choose them

1. Identify the objective (for example, to increase passenger revenue by better use of each train).
2. Identify the critical aspects of performance needed to achieve it (more passengers; giving them what they value: punctuality, cleanliness and comfort).
3. Set targets to drive behaviour towards those aspects.
4. Measure actual performance and compare it with the target.
5. Communicate the results to the managers of responsibility centres, who can act on them.

For the train example the indicators would be the percentage of seats occupied, the change in the number of passenger journeys, the percentage of trains arriving late, the number of cancellations, and a customer survey score for cleanliness and comfort.

Areas, departments, industries and analysis

Common areas

• Human resources. A motivated, well-trained workforce is often vital. Indicators: labour productivity (output per hour, time per unit, calls handled a day); labour turnover; training days per year; absenteeism (a measure of morale); average hours worked; idle time; proportion of billable hours; headcount by grade.
• Customer satisfaction. Customers ultimately determine profit. Indicators: percentage of new and returning customers; percentage of subscribers renewing; satisfaction survey results; number of complaints; speed of resolution; later sales to customers who had complained.
• Quality. Closely linked to customer satisfaction; poor quality has a direct cost (replacement) and an indirect one (lost goodwill). Indicators: proportion of reworked items; proportion of returns; failure rates; successful inspections.

By department or function

Sales and customer service: calls per hour, conversion of calls to orders, proportion of returning and “very satisfied” customers, waiting time. Online sales: website visits, conversion rate (sales as a percentage of visits), return visits, down time. Distribution: delivery time from order to fulfilment. Inventory: average holding, wastage, stock-outs, returns to suppliers. Sustainability: share of materials from green sources, reduction in carbon dioxide emissions, share of recyclable packaging.

Research and development: number of new ideas and the rate at which ideas become products.

By industry

Airlines: seat occupancy, aircraft availability, time in the air, turnaround time. Manufacturing: build time, production line down-time, capacity utilisation. Hotels: room occupancy and customer satisfaction scores.

Analysing NFPIs

As with financial ratios, it is not enough to calculate. Explain the significance: does it show good or bad performance, and why? Look at the background in the question for a likely cause. Where performance is poor, suggest what management could do. Link the non-financial result to the financial one where possible (for example, rising returns will lead to lower revenue and higher cost).

Benchmarking

Benchmarking compares performance with another organisation or operation, used as a standard, to show strengths and weaknesses. There are three types. Internal: the best-performing branch or department is the benchmark for the others. Competitive: comparing with the most successful competitors, to see where they are better and plan to close the gap.

Operational: comparing one operation (order handling, warehousing) with the best in any industry, including those that are quite different, which may be willing to share their methods. Its limits: data on competitors is hard to get; units may not be comparable; copying a benchmark may not suit the organisation.

Layouts for analysing non-financial indicators

1. Calculate the rate or percentage for each year (for example returns as a percentage of units sold, and the number of units behind it).
2. Compare with the previous year, target and benchmark.
3. Interpret: what it means; possible cause from the case.
4. Link to financial results and to other indicators.
5. Recommend an action.

Percentages to one decimal place; each answer is rounded once, at the end.

Worked examples

1. The numbers.
   Units returned rose from 2% × 28,000 = 560 to 6% × 30,000 = 1,800, more than three times as many.
   Late deliveries rose from 5% × 28,000 = 1,400 to 20% × 30,000 = 6,000, more than four times.
2. Meaning. Sales grew by 7%, but service and quality have deteriorated sharply. Late delivery and returns are both customer dissatisfaction, and retailers may move to rival suppliers.
3. Possible causes. The growth in volume has overstretched production and distribution; quality control may have been relaxed to meet orders; staff may be overworked or inexperienced.
4. Financial effect. Returns cost handling, repair and lost sales; late deliveries may cost penalties and goodwill. The financial results for the year may look good while the base for next year’s sales is being damaged.
5. Recommendation. Investigate the cause in production and distribution, set targets for on-time delivery and returns, and give managers responsibility for them.

1. Turnover.
   A: 8 ÷ 100 = 8.0%.
   B: 12 ÷ 80 = 15.0%.
   C: 26 ÷ 120 = 21.7%.
   Branch A is the internal benchmark.
2. Excess leavers if B and C matched 8%.
   B: expected 80 × 8% = 6.4; excess 5.6; cost 5.6 × 450,000 = ₦2,520,000.
   C: expected 9.6; excess 16.4; cost 16.4 × 450,000 = ₦7,380,000.
3. Next step. Find what branch A does differently (pay, supervision, workload, training) and see whether it can be copied.

Expect variants: a table of mixed indicators with a request to rank them by importance, a requirement to design indicators for a stated objective, discussion of problems such as too many measures, and a requirement to link to the balanced scorecard.

Cost of quality

The cost of quality has four classes. The cost of conformance is prevention costs (training, quality planning, supplier vetting, preventive maintenance) and appraisal costs (inspection and testing). The cost of non-conformance is internal failure costs (scrap, rework and re-testing found before delivery) and external failure costs (returns, warranty claims, repairs, complaints handling and lost goodwill). A cost of quality report lists them and compares them with revenue.

Example. Prevention ₦6m, appraisal ₦9m, internal failure ₦14m and external failure ₦21m: total ₦50m, which is 12.5% of revenue of ₦400m. Failure costs are ₦35m, or 70% of the total. Spending more on prevention usually reduces failure cost by more than it costs, and external failures are the most damaging because they also lose customers. The report links quality indicators, such as returns and rework rates, to money.

Sources of information for monitoring quality

A company that wants to monitor the quality of what it supplies, such as a bakery, can draw on several sources. Internal: inspection and test results, scrap and rework records, production and hygiene audits, machine and process data. Customers: complaints and returns, satisfaction surveys, customer service calls, social media comments, mystery shopper reports. Suppliers: quality of ingredients received, supplier audits and certificates.

External: regulators and standards bodies (such as food safety inspections), trade bodies, benchmarking data from competitors, media reports and independent laboratory tests. Internal data is timely and detailed; customer data shows what the market actually experiences, including problems that internal checks miss; external sources give independent assurance and comparisons.

Laying out a cost of quality report

Use the four headings. Show each item as quantity × rate, a subtotal for each class, and each class as a percentage of the total. Training and design or process engineering go under prevention; inspection and product testing under appraisal; rework under internal failure; customer support, transport and warranty repairs of defective units, and the contribution lost on sales lost through bad publicity (units lost × contribution per unit) under external failure.

The lost sales are an opportunity cost, often the biggest item, which shows why spending on prevention and appraisal pays.

Common mistakes

• Calculating without interpreting. The marks are for the explanation.
• Listing indicators not linked to the objective.
• Using the same indicators for every business.
• Ignoring the link to financial results.
• Too many indicators that confuse managers.
• Setting targets without owners.

Quick revision

• Financial results come from non-financial causes; measure both.
• Process: objective → critical aspects → targets → measure → communicate.
• Areas: HR, customers, quality. Benchmarking: internal, competitive, operational.
• Interpret: meaning, cause, improvement.

How the marks are earned

• Indicators chosen for the objective.
• Calculation and comparison.
• Interpretation and recommendation.

Practice questions

These are original questions, written in the style of the Skills examination. Work each one before you open the answer.

Recall check: multiple choice

Section B style: written questions

Model answers

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