Introduction
Business intelligence presents an opportunity for managers and leadership to attain a holistic and consistent view of their company’s performance and health. Standardizing, automating, and processing data can offer valuable analytical opportunities and insights to management to understand their business’s operations and performance. But, for management, there is a distinct difference between passively monitoring your business’s performance and health, versus proactively tracking and scrutinizing forecasts to supplement the decision-making necessary to grow and increase value generation of the business. The distinction between these two business intelligence systems is the inclusion of leading indicators to complement their lagging indicators.
What Leading Indicators Actually Tell you
Leading indicators are measurements that help predict future performance. Usually, leading indicators are metrics that tends to shift ahead of a broader trend, and act as an early signal for direct performance before it is reflected and shown in longer periodized reporting. Sales pipeline volume, order backlog, staff utilization, and customer sentiment are examples of leading indicators that move in advance of impacts to revenue. Leading indicators can be identified or calculated based on assumptions on how the target metric is influenced or calculated, and can vary between different industries, business models, and target metrics (see Exhibit A).
Exhibit A: Examples of how different companies may forecast target metrics using leading indicators
Lagging indicators, in contrast, sit on the opposite end of the spectrum as being more retrospective. Metrics like net income, EBITDA, and a completed income statement lag because they reflect activity that has already occurred. These two indicators serve different purposes: lagging indicators confirm what has happened and remain essential for accountability, compliance, and historical analysis, while leading indicators exist to anticipate what is about to happen, giving management the chance to act while there is still time to influence the outcome.
Complementing Lagging Indicators with Leading Indicators
While lagging indicators display financial milestones and can inform management on whether targets are being hit or missed, the time in-between reporting periods often lack pre-emptive signals on whether corrective action is needed, ultimately restricting the ability for the organization to react and adjust quickly. For example, by the time the business’s quarterly performance is reported, the window to drive action and improve the quarter’s performance has already passed. Lagging indicators can only flag issues retrospectively, and depending on reporting windows, the underlying bottlenecks could be lying undetected for weeks or even months at a time. Additionally, once the flag is identified, analysts and managers still must work to diagnose the causes driving that issue, which can cause even more delays in performance and growth.
Consider a professional services firm that tracks monthly and quarterly revenue closely but lacks reporting on staff utilization. By the time a slow quarter shows up in the financials, the drop in billables or productivity rating that had occurred weeks and months earlier had already gone unnoticed for some time. The firm now has to work backwards to root out the issues. Leading indicators like utilization, project progression, and market sentiment, tracked weekly rather than discovered monthly, are exactly the kind of metrics and data that would allow management to proactively manage their revenue generation, and quickly redeploy staff or adjust project timelines before revenue and growth for that quarter takes a substantial hit.
Conclusion
By using a combination of leading and lagging indicators, management can get a better sense of not only how the business performed in the past, but how they are trending in the near term. Leading indicators help to derive insights at critical parts of the value creation chain and help empower companies to make better decisions.
