Every business faces various risks. One example — and there are countless possibilities — is if a company’s payment terms are too lenient or methods for collecting payments are inefficient, it can increase the risk of default, which could lead to problems with cash flow or clientele management.
The assessment of risks is a process that involves the use of key risk indicators (KRIs). KRIs are an important component of enterprise risk management because they provide a signal to potential negative events that the company wants to avoid. A KRI can act as an early warning sign to notify the organization that a certain risk level has escaped containment, prompting administrators to act in time to prevent problems from materializing. The use of KRIs is most common in management of the company’s financial, cybersecurity, operations, and compliance aspects.
With the information below, you can identify what a KRI is, how to approach the creation of KRIs, and tools that can assist you in KRI management.
KRI vs. KPI: What’s the Difference?
Although KRIs are commonly confused with KPIs, they are distinct. In essence, a key performance indicator measures what has happened, while a key risk indicator assesses what could happen. Both are key components of Governance, Risk and Compliance (GRC) strategies.
KPIs and KRIs take a different approach to looking at a particular issue. Specifically, KPIs measure progress toward a specific goal, using concrete data and metrics for existing situations. KRIs also use data, but they focus more on predictive scenarios than past actions.
Businesses can use both in the assessment of performance factors, but KRIs focus exclusively on the possibility of a negative event happening. Both are critical for business intelligence, as one can guide decision-making, while the other assesses the effects of those decisions.
Different Approaches to the Same Scenario
To see a clear comparison, let’s look at ways of assessing KRI and KPI for canceled subscriptions. Customer churn can be a significant problem for cash flow in a Subscription-as-a-Service (SaaS) company, requiring close attention to the loss of paying clientele. KPIs might measure the number of customer cancellations within a month, while tracking other factors like new customer signups or requests for more information. These KPIs can help businesses track the rate of cancellations and total number of active accounts, so they know whether they are meeting revenue targets or whether the cancellation problem is getting worse.
KRIs for customer cancellations take a different approach. They do not necessarily measure the rate of the negative event actually occurring. Instead, they may look at the number of customer complaints, or a drop in use of the software that statistically precedes a cancellation. These KRIs provide data that the business can use to determine the likelihood of a cancellation, so they can take action to prevent it.
Common Types of KRIs
KRIs monitor risk levels in various aspects of company operation. Many KRIs are industryspecific. For example, a manufacturing business might assess inventory management as a risk factor for production timelines, while a SaaS company may focus on service outages. These KRIs can apply to many businesses in various industries:
Financial: Financial aspects of a company have the potential to help or hurt operations, growth plans, investor interest, and more. Financial KRIs emphasize issues that can lead to problems with revenue generation or expenses, like liquidity ratio or credit default rate. They may also measure potential for problems related to the market as a whole, such as volatility, an increase in financial cybersecurity attacks, threats to the viability of the company’s financial institution, or political instability.
Cybersecurity: A breach of the company’s site or systems can hurt its reputation and disrupt operation, calling for close attention to each potential threat to cybersecurity. Useful KRIs for cyber risk focus on various factors, such as the number of phishing attempts, frequency of vulnerabilities, or the existence of unauthorized access incidents. Setting thresholds for each risk indicator can assist businesses in determining the chances of a data breach, so they can shore up their defenses.
Operations: Keeping operations in check is vital to ensure that the business keeps running from day to day. Operational KRIs might include the duration of downtime events, rates of errors in production, and delays in the supply chain. Each indicator helps the company identify weaknesses in operating procedures that may interrupt production or other critical functions.
Regulatory Compliance: Compliance with regulations is important for investor confidence and other business concerns. Companies can set KRIs for compliance to determine the likelihood that they will fail to provide a correct filing, such as the number of audit findings, delayed SEC filings, or compliance breaches. These KRIs can provide early warning signs that the business needs to adjust its compliance processes.
How to Develop Effective KRIs
In general, an effective KRI requires a number of qualities. Specifically, it must be measurable, comparable, relevant, and timely. Measurable KRIs provide viable data that lead to responsible decision-making. Comparable KRIs allow the business to evaluate how the risk changes over time, or how it compares to other risks. Relevant KRIs apply to the business as it is, offering applicable information. Timely KRIs provide alerts at the right time, so companies can minimize the risk or prepare for the outcome.
Follow these best practices to create useful and practical KRIs:
Identify Key Risks and Objectives: Businesses should start by evaluating each key risk they could face. Key risks relate to operations, markets, and other factors. After a comprehensive risk assessment, companies should define a set of strategic objectives they hope to achieve. This information allows businesses to assess how each risk event could influence their ability to meet these objectives. The process makes it easier for companies to define KRIs to provide advance notification that they may not meet their objectives.
Assign Responsibilities: Setting KRIs requires attention and accountability from the start. Initially, a business’s administration should review and approve the KRIs. Once KRIs are set, the organization must assign people to generate reports that assess risk and review alerts. These assignments should be clearly communicated and transparent, to ensure that relevant personnel regularly monitor the KRIs and consider warnings as they come up.
Determine Thresholds: Each KRI needs a threshold that triggers an alert when the data shows the risk level has exceeded recommendations. This step requires an examination of the organization’s goals and risk appetites, because a risky maneuver does not necessarily require an immediate fix. Businesses might be willing to lower some thresholds to allow for short-term market volatility, for example, while keeping operational KRI thresholds high to ensure optimal productivity.
Validate Data Sources: Evaluation of KRIs requires access to timely, accurate, and relevant data sources. Businesses should implement a plan for data collection and evaluation that relates closely to the KRI. Sources might include financial reports, operational metrics, or outside data that measures market volatility, employment rates, and more. Regular validation of each KRI data source ensures that the information coming in is applicable and timely.
Using KRIs for Risk Monitoring and Reporting
In order for the KRI framework to provide critical warnings about a changing metric beyond the company’s tolerance, regular monitoring and reporting are key. Ultimately, the goal is to create standards that tell the business when and how to be proactive about preventing negative events before it is too late to hinder their progress.
KRI monitoring usually requires the use of software to assess risk in real-time and generate alerts when indicators approach or exceed specific risk thresholds. Ideally, the alerts should trigger a documented action within the company. For example, if a KRI identifies a significant decrease in revenue within a specified time, the alert can trigger the company to evaluate strategies to manage cash flow and work to improve revenue generation.
Routine reporting for KRIs is important for executives and other stakeholders. Reporting allows the business’s administration to evaluate progress toward minimizing risk or adjust risk tolerances based on performance. It provides vital data to help with decision-making for the future of the organization, within allowable risk levels. The company should implement standardized processes for generating and reviewing reports, so that the reporting frequency is predictable and the information guiding decisions is current.
The Role of Technology in Managing KRIs
Technology plays an important role in helping businesses manage their KRIs and ensure real-time detection. Although companies can manually calculate data to assess KRIs, this tactic requires much more human effort and can increase the likelihood of errors. By comparison, technological assessment of KRIs can provide a number of benefits, including:
- Centralization of data, so it is accessible to all stakeholders
- Consistency of information across KRIs, minimizing bias or insufficient data collection
- Clear audit trails that allow the company to assess accuracy of data and meet compliance standards
- Real-time insights that provide current data on existing KRIs, useful for planning and reporting
Integrated software platforms with AI capability can streamline data collection and provide analytics to inform predictive models:
Software Platforms: Software platforms make information about company function and KRI performance available at a glance for relevant parties. Governance, risk and compliance (GRC) platforms integrate with other operational software, providing a seamless system for data collection and processing. The system offers regular data feeds and updated analytics, so administrators can view this information quickly. Critically, the software also generates alerts when risks rise above the threshold, prompting quick assessment and action to minimize the risk or the extent of damage.
AI Assistance: The integration of AI into software systems paves the way for effective KRI creation and tracking. AI excels at predictive modeling through its access to large data sources, quick processing, and pattern recognition. An AI-integrated system can take existing company data and compare it to historical data from similar businesses. This information assists in generating predictive models through pattern recognition and other tools. As a result, organizations can use the models to help identify high-risk scenarios that can guide the selection of KRIs and necessary thresholds.
Final Thoughts on the Strategic Value of KRIs
In the modern risk landscape, KRIs remain a critical component of operational risk management. Businesses need to know the risks they face based on the function of the company, its industry, and future decisions. KRIs provide vital early insights into situations that may cause the business to falter or fail if left unattended. Regular refinement of KRIs offers a way to stay ahead of constantly evolving threats and regulations. Additionally, KRI management and integration help increase stakeholder confidence in the company, reduce uncertainty around likely situations, and improve resilience under pressure.
For the most effective KRI implementation, businesses need assistance from experts like DFIN. DFIN specializes in software solutions for regulatory reporting, governance, and data analytics, paired with expert services to help businesses streamline their KRIs to meet regulatory SEC expectations and internal audit controls. To learn more about our services and how we can help your organization improve your risk management strategies, request a demo today.