Linking Non-Financial Metrics to Financial Performance
In accounting analytics, most of the predictions and calculations are done with numbers that come directly out of a financial statistic that the company gives, or a financial prediction that a company forecasts. However, in certain situations when making key managerial decisions at a company, one has to utilize non-financial metrics to the maximum due to three reasons: 1. Cash flow can be forecasted from the company’s investments in intangible assets. 2. Projects should be chosen based on which has the highest expected payback rate, and non-financial metrics are very useful for that. 3. Financial metrics are not the only factors that go into considering and evaluating managerial and/or business performance.
Some of the key questions to ask when measuring non-financial metrics are: What should the company measure? What are some of the key drivers to financial success? How do we evaluate the rank of various non-financial measurements? How does one make tradeoffs of different non-financial measurements? What are some appropriate performance targets/standards? Etc. Some possible methods of answering these questions can be using Intuition, Management Consensus, Measurement Framework, and carrying out Informal Data Analysis.
However, what we really want in this process is a rigorous predictive analysis technique, and the Performance Measurement Theory provides a structure for this particular analysis. Firstly, we have to develop and explicitly casual business model that shows how the strategies the company is using are linked to its value drivers. Then, the company has to identify some specific value hypothesis and propositions, following that up with an actual test of those hypotheses. Finally, we then have to incorporate those results in a decision making process and evaluate the financial performance of a company in a set period of time.
Next week, I’ll get into some more specific examples of how this is done.
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