Why Most Companies Track the Wrong Numbers
The Financial Planning & Analysis (FP&A) function plays a critical role in business decision-making. Their primary mission is to ensure the company is on a profitable and sustainable path.
However, most companies still track 'vanity metrics'—numbers that look impressive but do not actually drive meaningful growth or business decisions. These metrics, such as website views or social media followers, are often poor indicators of profit, efficiency, or customer value.
As a successful FP&A professional, you need the skill to select the vital few financial metrics that are directly linked to the company's strategy and propel the business forward. This is where the six-step framework, proposed by finance expert Christian Wattig, becomes indispensable.
The Foundation for Success (Steps 1-3)
Selecting the right financial metrics is not just an art; it is a systematic science that must begin with the company's core strategy.
Step 1: Internalize the Company’s Strategy
The first and most critical step in choosing the right metrics is understanding the company’s overall strategy. What does the company aim to achieve in the short term? What is the long-term objective?
For instance, a new startup might prioritize increasing market share and acquiring new customers as its strategy. Conversely, a well-established company might focus on maximizing profit margin and improving return on investment (ROI).
When the strategy changes, the metrics that need to be tracked must also change. Without understanding the strategic objective, any financial metric tracked becomes meaningless.
Step 2: Clearly Define Success: Converting Goals into Numbers
After understanding the company’s strategy, you must convert that strategy into a measurable goal. Stating, "Becoming a successful company" is an aspiration, not a goal. However, "Achieving 20% Revenue Growth within the next 12 months" is a clear, definitive goal.
When defining success, the goal must adhere to the SMART criteria: Specific, Measurable, Achievable, Relevant, and Time-bound. The precision of this goal definition will validate the quality of the metrics you select in the subsequent steps.
Step 3: Identify the Business Drivers
Once the goal is set, you must identify who and what actions are truly responsible for achieving that goal. These factors are known as 'Business Drivers.'
For an online sales company, if the goal is total sales, the key drivers might be:
- Website Traffic
- Conversion Rate (turning visitors into customers)
- Average Order Value (AOV) per customer
By understanding these drivers, you begin to track the causes that lead to financial results, rather than just the results themselves. FP&A professionals use these drivers to inform financial forecasts and assign accountability across different departments.
The Science of Metric Selection (Steps 4-6)
The first three steps focused on strategy and goal setting. The next three steps detail the scientific process for selecting the right metrics that will help achieve those goals.
Step 4: Brainstorming Ideal Metrics
After identifying the business drivers, you should list all possible metrics that could track their performance. At this stage, you should only focus on what the ideal metric would be, without worrying about data availability.
When thinking about customer value, ideal metrics might include:
- Customer Acquisition Cost (CAC): The total cost required to acquire a new customer.
- Lifetime Value (LTV): The net profit a customer is expected to generate over their entire relationship with the company.
- Transaction Volume: The total number of sales transactions within a specific period.
It is crucial to include both financial metrics and operational metrics in this list, as operational performance dictates financial outcomes.
Step 5: Assessing Data Reliability and Availability
The long list of ideal metrics created in Step 4 must now be subjected to a reality check. No matter how great a metric is, it is difficult to implement if you lack reliable data for it.
In this stage, FP&A professionals must ask the following questions:
- Do we have the raw data required to measure this metric?
- How easily, accurately, and quickly (daily, weekly, or monthly) can this data be collected?
- Is the data reliable? Are there errors or human intervention in the data sources?
If data collection is too costly or time-consuming, you may have to discard an 'ideal' metric and choose an alternative that is close to the goal but easier to obtain. This is the crucial trade-off between practicality and ideality.
Step 6: Making the Final Selection Based on Feasibility
In the final stage, you must compare your list of ideal metrics against their data feasibility. Select only those metrics that satisfy both criteria—the "Vital Few."
- Ideality: How closely is the metric aligned with the company’s strategy?
- Feasibility: How easily can you track the metric with reliable data?
Be disciplined in deciding which metrics to reject. It is more successful for an FP&A team to track three to five highly meaningful metrics accurately than to get lost in a sea of ten or more confusing metrics. This process results in a clear, goal-oriented system that is understandable across all departments.
Non-Negotiable Technical Financial Metrics for FP&A
Regardless of the 6-step framework, certain technical financial metrics are universally essential for any FP&A team to track:
- Gross Margin: The percentage of revenue remaining after subtracting the cost of goods sold (COGS). This metric indicates how efficiently a company produces its products.
- Operating Expenses (OpEx): The money spent on administration, sales, and research. Properly tracking OpEx is vital for managing cash flow.
- Cash Runway: The number of months a company can cover its expenses without any new revenue. This is a critical financial metric, especially for startups.
The Perpetual Journey to Performance
Selecting financial metrics for FP&A is not a one-time task. As the market changes and the company's strategy evolves, this framework must be revisited to review and update the metrics.
By adopting this six-step framework, FP&A professionals transition from being mere 'data collectors' to becoming 'strategic partners' in the business. Focus only on the accurate and reliable metrics that drive your decisions, thereby ensuring your company moves toward a profitable future.
Frequently Asked Questions (FAQs)
Q1: What are 'Vanity Metrics'?
A: These are metrics that look impressive but are useless for making business decisions. Examples include the number of likes on a post or impressions, as they do not directly impact a company’s profit or cash flow.
Q2: What is the maximum number of financial metrics a company should track?
A: While the number depends on the size of the company, experts recommend that the best FP&A teams primarily track only three to seven critical financial and operational metrics, known as "The Vital Few." Too many metrics lead to confusion and distraction.
