We all know that studying a company’s financial statements is the best indicator of a company’s financial health. Analysts and investors also consider other financial measures, such as ratio analysis, to understand the financial position. However, over the last few years, experts and analysts are also using non-financial performance measures to understand and reveal the things that financial measures don’t tell.
In the simplest form, the non-financial performance measures give you the information on a company’s performance in non-monetary or non-money terms. Though one can’t express non-financial measures in money terms, these measures can be qualitative and quantitative.
Usually, these measures help understand the quality of the product or service that a company offers. For instance, an airline uses several non-monetary measures to gauge its performance, such as customer complaints, instances of lost baggage, on-time performance, and more.
Importance of Non-financial Performance Measures
The following points help in understanding the importance of non-financial measures;
- These measures support the financial measures or KPI (key performance indicators). Most financial measures are lagging indicators, which means they reflect what has already happened. For example, the revenue that a company earns from selling the product last year. Thus, management uses non-financial measures to get an idea of future financial performance.
- Management also needs non-financial measures because it is easy to link them to the company’s strategy. Companies don’t have their vision or mission statement in money terms. For example, if a company’s mission is to be the number one service provider, then its revenue won’t help track the progress towards the mission. In such a case, customer satisfaction scores will prove a good measure.
- Third, many believe that “intangible assets” such as customer loyalty and patents play a bigger role in a company’s success than tangible assets. It often gets difficult to quantify intangible assets in monetary terms. Thus, a company can use non-financial measures to get quantitative and qualitative data on intangible assets.
- Financial indicators do not give the full picture. For instance, they don’t tell why the sales are dropping or why the cash flow is reducing. To get answers to such questions, management turns to non-financial measures.
Benefits of Non-financial Performance Measures
Following are the benefits of non-financial measures;
Track Strengths and Weaknesses
If a company performs better in solving customers’ concerns, but customers had to wait for a long time for this, then non-financial measures, such as a simple feedback form, would catch this. Thus, these measures help reveal the core competencies and the areas that need improvement.
Reveal Business Performance
The financial performance of a business automatically reflects in the bottom line. Any under or over performance can be easily tracked to the source using non-financial measures. For example, an increase in the HR budget could reflect a high turnover rate.
Feedback to Employees
As already said (in the importance section) above, non-financial measures help support the company’s strategies. Thus, the departments and employees know what efforts they need to make to meet the objectives. Also, non-financial measures help employees understand how small things make a big difference, such as their daily attendance helps boost productivity. We can say that non-financial performance measures help establish a connection between the strategies and daily tasks.
Assess Impact of External Factors
There are several types of external risks that a business faces. Such risks are not in a company’s control, such as recession, the act of God, war, and more. These risks impact the revenue and expenses of a company. In such situations, looking only at the financial indicators could provide a dismal picture of a company. Thus, using non-financial measures give a more holistic view. For instance, if you are getting good scores in customer service and customer satisfaction during such times, it would mean that the companies would get on track soon after the macro factors get favorable.
Though non-financial measures have many benefits, there are a few drawbacks to them. These are;
- A company that uses too many non-financial measures spends a lot of time and money on its implementation. Thus, it may happen that the time and cost spent on these measures may outweigh their benefits. Moreover, too many measures also require significant investment in the IT infrastructure.
- The use of non-financial measures increases the workload on the management as well. Management needs to give extra time first to implement these measures. And then spend time evaluating the results and communicating the same to the employees.
- If a company suffers from bureaucracy, then there are chances that the non-financial measures could turn into mechanical exercises with no real contribution.
- Unlike financial measures, there are no fixed ways to measure non-financial data. Thus, different companies could use different ways to measure the same non-financial measure. This makes the comparison of non-financial measures difficult.
- Often companies adopt non-financial measures just for the sake of adopting them. They don’t give much thought to linking it to objectives or its effect on the accounting and stock price. This again leads to a wastage of resources and time.
- Many a time, the accuracy of the non-financial measures is also a question. There are often doubts if the result represents what it is supposed to or is just a measurement error. Such errors come into play when a company uses statistical measures. For instance, when a survey is based on a response from a few respondents, the statistical reliability could be poor.
The following are some of the common non-financial performance measures. Companies primarily use these measures to evaluate the performance in relation to the customers, internal processes, and Learning & Growth.
To measure the performance in relation to the Customers, a company can use Conversion Rate, Retention Rate, Customer Satisfaction, Customer Complaints, wait time for the customer, and Brand Recognition.
For measuring the performance in relation to the Internal Processes, a company can use Instances of Customer Support, Product Defect Percentage, Order accuracy, On-Time Delivery, and Production efficiency.
To measure the performance in relation to Learning & Growth, a company can use the Average Time to Hire, Salary Competitiveness Ratio (SCR), Employee Productivity Rate, Internal Promotion Rate, and Turnover Rate for Highest Performers.
Read more about other Methods of Financial Analysis.
From the above points, it is clear that non-financial performance measures are also very important for a company. They help the company to reveal things that financial measures don’t tell. And, their proper implementation could help in the all-around development of a company. However, these measures should be considered along with the financial ones; otherwise, they may not give the desired results.
Quiz on Non-financial Performance Measures