What are Leading vs Lagging Indicators?
You have information that will save you from disaster!
I recently noticed some posts and discussions around the often-quoted indicators of financial difficulties for businesses. In general terms a business in financial difficulties will demonstrate a number of indicators such as tight working capital where current liabilities exceed current assets, overdue and unpaid amounts due to suppliers, and the taxation office.
Another indicator may include trading losses. This is not the complete list by the way.
My idea is a simple one, if you are unorganised then business is difficult; getting organised is easy.
I want to be forward focused here and explore the difference between the indicators noted earlier, which I will call lagging indicators and another set called leading indicators. I well understand these lagging indicators are more to assist with insolvency and the various tests that are applied to determine insolvency and when a business may have started to become insolvent. No problem here.
Forward focus is where the leading indicators help you get organised.
Leading and lagging indicators are two types of performance metrics used to measure progress to whatever goal or objectives you may have set for yourself. The main difference between leading and lagging indicators is when they are measured and what they can tell you about your performance.
Leading indicators are predictive metrics on future performance. These are “early” indicators as they help identify potential issues or opportunities before they occur. They are usually quantitative, but don’t need to be. By using leading indicators to anticipate future events, you can take proactive measures to prevent potential issues from arising.
Example of Leading Indicators
A builder is experiencing a high employee turnover rate, a lagging indicator. We all understand the state of skill shortages in the marketplace now, so staff are critical to ongoing success. But what if you had systems in place which alerted you earlier so you can understand and stay on top of staff?
A much better use of resources. By addressing these issues proactively, you could reduce the likelihood of future turnover and create a stable workforce.
A builder may use pipeline conversion rates as a leading indicator to anticipate future revenue growth and consequently better manage resources. By identifying areas of the sales process where leads are dropping off, you can make improvements to increase your conversion rate or redeploy resources.
You could get more sophisticated and start to stratify this – inquiries, which may convert to consultations, then quotes and then contract sign off.
You have everything you need!
I bet you have a stack of information currently existing within your business which would help you develop a matrix which says for every new building start, I need X number of quotes in the pipe, which means I need X number of consultations happening, because I know my conversion rates from consultations to quotes. To do that I need X number of enquiries on my website because I also know how many enquiries convert to consultations.
If these targets are not being met, then this may lead to a slowdown in work. So now you can predict that based on what’s in the pipe and if that should stay the same, you will have a slow period coming up because you also know from your business how long it takes to convert the signed contract to feet on the ground to start the build.
Now you take two steps
The first is you double down on your marketing efforts and understand what is happening. Is it me? Is it the market? Is it interest rates? What can I do about this? A new marketing strategy?
Two, you keep your eyes up and look to the horizon for strategies to deal with this if the predictions come true. That would include managing your resources and people to get through the downturn.
That doesn’t mean you move people on; it may in fact mean you fast track work to bring forward profits and cash. When you have the cash, you have options and that’s a good spot to be in.
This future focused state is much easier to manage.
Example of Lagging Indicators
A brief history of time
Lagging indicators, on the other hand, are retrospective metrics that are measured after a period has passed. It is a story. A historical recount of events. They are “after-the-fact” indicators as they provide insight into what has happened. These indicators are typically quantitative and are used to evaluate the success or failure of a particular strategy or initiative.
Again, for a builder, a lagging indicator for example would include revenue, gross and net profit margins etc.
What you need
A combination of both these measures is what you need to track and analyse business performance.
This will provide a more comprehensive view and help you make decisions to achieve your goals.
Remember the idea, if you are unorganised then business is difficult; getting organised is easy.