KPI

What is a KPI?

KPI (short for Key Performance Indicator, in German Leistungskennzahl or Schlüsselkennzahl) denotes a metric that measures how far a company or a business unit has achieved an essential objective. A KPI differs from the other metrics of accounting through its steering function: those responsible base their decisions on it, and a change in its value triggers a reaction. It is comparable to the few gauges on a car's dashboard, which do not show everything but do show what the driver has to react to.

Management uses KPIs in controlling, which supports corporate management in planning, steering and monitoring, and in monthly internal reporting (management reporting). Investors receive them on the basis of contractually agreed information rights in the investor update. Lenders attach contractual financial covenants to them, and company purchase agreements use them as the basis for calculating variable parts of the purchase price.

The German Commercial Code (Handelsgesetzbuch, HGB) also uses the term, namely in the management report (Lagebericht), which supplements the annual financial statements with a presentation of the course of business and the position of the company. Capital companies (Kapitalgesellschaften) that must prepare a management report include the most significant financial performance indicators in the analysis of the course of business (Section 289(1) HGB). Large capital companies additionally take non-financial performance indicators into account insofar as they are of significance for an understanding (Section 289(3) HGB).

Requirements for a KPI

A metric is suitable as a KPI only if it is clearly defined and always calculated in the same way. In practice, a profile sheet is created for each metric:

• Definition and formula: “Active customers” is not a definition; “customers with at least one invoiced service in the last 30 days” is one.
• Data source: accounting, contract data, sales system or product analytics, each with the exclusions, for example for test and employee accounts.
• Periodicity and reporting date: whether the value is determined as of month end, as a monthly total or as a moving average.
• Responsibility: one person who explains the value and initiates measures.
• Target value and thresholds: a plan value for the period and thresholds above which a deviation is reported to management.

A further requirement is controllability. An exchange rate or a market interest rate belongs in the report as a framework variable but is not a KPI, because nobody in the company steers it.

KPIs are brought together in a dashboard, an overview with time series, plan value and deviation for each metric. The ongoing recording and observation is called KPI tracking or KPI monitoring in practice.

Types of KPIs

Leading and lagging indicators

Lagging indicators show the result of past decisions: revenue, earnings, customer churn. They can be measured reliably, but report problems only when these can no longer be averted. Leading indicators come before them, for example the number of qualified sales opportunities in the sales pipeline, the share of new customers who use a core function in the first weeks, or the utilisation of customer service. An effective system of metrics combines both: for every important lagging indicator there is at least one leading indicator with a documented link.

Financial and non-financial metrics

Financial metrics come from accounting, for example revenue, gross margin, EBITDA (earnings before interest, taxes, depreciation and amortisation), burn rate (monthly consumption of liquidity) and liquidity runway. Non-financial metrics describe customers, product and organisation: number of customers, usage intensity, cancellation rate, satisfaction (measured, for example, as CSAT), employee turnover. For investors, the non-financial variables often explain the financial ones, because they show why revenue is growing and whether the growth will continue.

Metric systems

Individual KPIs are arranged in a hierarchy: a few metrics for the company as a whole, beneath them a few variables for each business unit that feed into the higher-level ones. Widespread are KPI trees, which break a target variable down arithmetically into its drivers, and the balanced scorecard, which sets finances, customers, internal processes and learning and development side by side. Many technology companies additionally place a North Star Metric at the top, an overarching usage metric to which some of the other KPIs contribute.

KPI examples by business model

The business model determines which metrics are at the centre. For software companies with subscriptions, annual recurring revenue (ARR) and its growth are the most important variables. Added to these are net revenue retention, that is, the revenue from the same customers compared with the previous year after expansions and cancellations, as well as the churn rate and gross margin. They are supplemented by customer acquisition cost (CAC), the time until it is paid back (payback period), and the value of a customer over the entire business relationship (lifetime value, LTV). Together, these variables describe the unit economics, that is, the profitability per customer.

Marketplaces report transaction volume, commission rate and the share of enquiries successfully brokered. In online retail, basket value, repurchase rate and contribution margin after marketing costs are to the fore. Irrespective of the model, liquidity, burn rate and runway belong in every report to investors.

KPIs in funding rounds, due diligence and company acquisitions

In a funding round, KPIs form the basis of the equity story and the valuation. Besides the values, investors examine the quality of the metric system: whether the definitions are stable, whether the values can be derived from accounting and contract data, and whether management explains deviations. Under Section 51a of the German Limited Liability Companies Act (GmbHG), shareholders have a statutory right to information and inspection. The scope and frequency of reports are set by the participation agreement or shareholders' agreement, usually with a monthly KPI report.

In due diligence, the reported metrics are reconciled with the accounts. Differences between recurring revenue and revenue, between customer numbers in the sales system and invoiced customers, or between the reported and recalculated churn rate must be explicable. In the company purchase agreement, KPIs serve as the basis for an earn-out; the definition then becomes part of the contract, including the accounting rules and the consequences of later changes by the buyer. Whether the seller's warranties also extend to management metrics or remain limited to the annual financial statements is regularly a subject of negotiation.

Worked example: reconciling ARR as a KPI with revenue

A software company reports monthly recurring revenue of EUR 300,000 as of 31 December and thus an ARR of EUR 3.6 million. Revenue according to the annual financial statements for the same year is EUR 3.23 million. The difference is reconciled in the due diligence:

• ARR at the reporting date: EUR 300,000 × 12 = EUR 3,600,000
• Recurring revenue of the year: on average EUR 240,000 per month × 12 = EUR 2,880,000
• One-off revenue from implementation and training: EUR 350,000
• Revenue according to the annual financial statements: 2,880,000 + 350,000 = EUR 3,230,000
• Difference: 3,600,000 minus 3,230,000 = EUR 370,000
• Reconciliation: reporting-date effect of 3,600,000 minus 2,880,000 = EUR 720,000, less the one-off revenue of EUR 350,000, gives EUR 370,000

Both values are correct; they measure different things: the ARR describes the level at year end, the revenue the total for the year including one-off revenue. It becomes problematic when investor documents call the ARR revenue or include one-off implementation revenue in the ARR. In the second case the reported ARR would be EUR 3.95 million and thus around 9.7% above the correctly delimited value. When a valuation is based on a multiple of ARR, this deviation passes directly into the enterprise value.

Distinctions: KPI, metric, OKR, controlling and covenant

• Metric: any condensed figure about the company. A KPI is a metric with a target value, responsibility and steering effect.
• OKR: a method for setting objectives for a limited period. KPIs are observed permanently; a KPI becomes a key result for a quarter if it is to be changed deliberately.
• Controlling: the task of supporting corporate management with planning, metrics and reports. Controlling defines and collects the KPIs and reconciles them with the plan.
• Covenant: the contractual obligation towards a lender to comply with certain metrics. The KPI thereby becomes a contractual condition with legal consequences if breached.

Common mistakes

• Too many metrics. A report with several dozen metrics of equal rank steers nothing, because nobody can see which deviation calls for a reaction.
• Changing definitions. A changed calculation without recalculating the prior periods makes time series worthless and costs trust with investors.
• No reconciliation to accounting. Metrics that cannot be derived from accounting and contract data are rebuilt in the due diligence, with loss of time and an open outcome.
• One-sided incentives. If only the number of new customers is measured, their quality often falls. Counter-metrics such as churn rate or contribution margin belong in the same pair of metrics.

Frequently asked questions

How many KPIs does a growth company need?

As a rule of thumb, five to ten at company level, supplemented by a few variables per business unit. More important than the number is that the selection stays the same over several quarters and that each metric has a responsible person.

Which KPIs do investors expect in a Series A?

For software companies, almost always recurring revenue and its growth, cancellations and net revenue retention, gross margin, customer acquisition cost with payback period, and burn rate and runway. Investors pay less attention to the selection than to whether every figure can be derived from the source data.

Which KPIs exist in sales and marketing?

In sales, the number and volume of qualified sales opportunities, win rate, length of the sales cycle and average order value are common. Marketing measures the number of qualified prospects (leads), the cost per lead, the conversion rate to paying customer and customer acquisition cost.

Are KPIs mandatory in the management report?

For medium-sized and large capital companies yes, because they must prepare a management report; large ones additionally report non-financial performance indicators. Small capital companies are exempt. For reports to investors, by contrast, whatever is agreed in the participation agreement applies.

May the definitions be changed?

Yes, if the change is disclosed and the prior periods are recalculated under the new definition. If that is not possible, both series are run in parallel for a transition period so that the break remains visible.

The Roemer Capital view

KPIs are one of the four pillars around which Roemer Capital aligns the preparation for a funding round, alongside runway, unit economics and governance. The focus is less on the level of individual values than on their reliability: every metric in the pitch deck and data room needs a written definition and a reconciliation to accounting.

In fractional CFO mandates, that is, as a finance function on a part-time basis, Roemer Capital sets up monthly reporting so that definition and source stand beside every value. The data room can then be made available within 24 hours. Investors' follow-up questions concern the development of the business rather than the origin of the figures.