Most Companies Measure the Wrong Things

If what you focus on, you get, then can’t we apply the same idea to business? What you measure is what you will get. But if you’re building a business, you may wonder how to actually measure success across the entire organization. In this article, I hope to shed some light on that question based on my experience working with hundreds of companies and spending thousands of hours building financial models and KPI dashboards that drive real performance improvement.

Notice how I emphasized the word real in the last sentence? I did that intentionally because, in my experience, too many companies fall into one of two traps. They either measure nothing at all, or they measure everything they can think of, including whatever ChatGPT tells them to track. Neither approach works. One leaves you guessing without data, while the other leaves you overwhelmed, staring at a massive spreadsheet filled with rows and columns of numbers but no clear story.

So let’s start here. Words matter, so I want to be precise. When I refer to measures in this article, I am talking about key performance indicators, or KPIs, metrics, or any number, ratio, or percentage used to evaluate something in your business. At their core, measures are simply answers to questions you have about your company. And once you have the answer, it should give you enough insight to take action, adjust behavior, and improve results.

Let’s go a little deeper. Imagine you are wondering whether you are priced correctly in the market. One place to look for that answer is your gross margin. Or suppose you want to know whether you have enough cash to make it to your next funding round in June. That answer might show up in your burn rate. Or maybe you are trying to understand whether customers actually like your product. The answer may be reflected in your churn rate. The point is simple. Every measure exists to answer a question about your business.

The problem is that many leaders skip the question entirely. Instead of asking, “What are the most important questions we should be asking to know if our business is healthy, if our customers are happy, or if our strategy is working?” they jump straight to the end. They list out a bunch of measures and then try to plug numbers into them. The result is a dashboard full of metrics but very little clarity about what actually matters.

Now look, having some measures is better than having none. But let me suggest a better path. When I start working with a business, I usually begin with one fundamental question: is the company’s strategy actually working? Keep in mind that every business has a strategy. The real question is whether it is a good one, and whether it follows a clear and systematic approach or simply lives in the head of the owner. So how do you know if your strategy is working? You could ask your team. You could point to a nicely designed document with your mission, vision, and values written on it and say success is when everyone understands those words. But there is a far more concrete way to answer this question, one rooted in the numbers.

If you have followed my work for a while, you know one of my favorite measures in business is the amount of free cash flow a company generates. In many ways, that is the ultimate measure of success. Not profit. Free cash flow. But free cash flow by itself is not enough, because it has to be relative to something. For example, a business might generate $1M in free cash flow each year, and that may sound impressive. But if it took $100M of investment to produce that $1M, the return is only 1%. Suddenly it does not look so great. That is why I like to use return on invested capital, or ROIC, to measure the effectiveness of a company’s strategy. ROIC is not perfect for every business. It may not work as well for very asset light companies like professional services firms, or for businesses with large upfront and uneven investments. In those cases there are other measures that may work better. But for the majority of companies, ROIC is one of the most useful ways to evaluate whether a strategy is truly creating value.

If we break ROIC into its component parts, the formula becomes simple: ROIC equals NOPAT divided by invested capital. NOPAT stands for net operating profit after tax, which is the money your business earns from its core operations after taxes. Invested capital represents the capital required to run the business. It generally includes current assets minus current liabilities, excluding excess cash and interest-bearing liabilities, plus operating assets such as net property, plant, and equipment.

So how does understanding this formula help us? First, it gives us a way to evaluate whether our strategy is actually working. For example, if your ROIC is less than about 10%, you may be underperforming the broader market. Historically, the S&P 500 has returned roughly 10% per year. That means, in theory, you could liquidate the assets in your business, invest the money in a simple index fund that tracks the market, and earn a similar return without employees, customers, or the daily headaches of running a company. Personally, I like to see businesses generate an ROIC above 20%.

Now we are back where we started. A company’s strategy has a major impact on its ability to generate cash flow. And since the value of any business is determined by the total cash it will generate over its remaining life, expressed in today’s dollars, it makes sense to focus on the measures that influence that outcome the most. Free cash flow is an excellent measure of value, but ROIC helps us understand value creation in relative terms. When you focus on improving ROIC, you are ultimately driving stronger cash flow and building a more valuable business.

Let’s go back to measures. If ROIC is a foundational measure of strategic effectiveness, and your business is generating a low ROIC, how do you improve it? The answer is found in the components of the formula: NOPAT and invested capital. NOPAT is influenced by four levers: pricing, volume, cost of goods sold, and operating expense. Invested capital is influenced by four additional levers: accounts receivable, inventory or work in progress, accounts payable, and capital expenditures. Together, these eight levers are the same drivers that ultimately determine free cash flow. When you see it laid out this way, it all starts to come together.

If you want to sharpen your focus this year and get serious about improving your business, start with one core measure like ROIC. Then understand the levers that influence it. In this case, there are eight levers that drive both ROIC and cash flow. Build measures around these levers, manage them well, and you will be on the path to building a financially resilient company. And if you ever want to talk through your company’s strategy or the measures you should be using to track performance, feel free to reach out at [email protected]. Cheers.

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