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How To Use Leading and Lagging Indicators To Create an Early Warning System for Change

August 24, 2020 Evan Webster  
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Market and business model changes can seem insurmountable—and planning with agility feels difficult when that change is looming. So how do finance teams stay on top of it?

When Vena surveyed 350 business leaders and finance and operations professionals for our recently released Q2-2020 Industry Benchmark Report, we wanted to find out exactly that. And there were some surprising conclusions. One of the most unexpected, though, was how unprepared many organizations are for change. Among the findings: more than half of organizations, at 56%, don’t have any kind of early warning system in place.

But what does an early warning system involve and why is it important? And what do you need to consider as you introduce one to your business? This blog post will cover:

  1. What is an early warning system?
  2. Why is having an early warning system important?
  3. Examples of leading and lagging indicators.
  4. Operational vs. financial reviews.
  5. Early warning systems in practice.

What Is an Early Warning System?

An early warning system is a set of data and processes that gives you insight into the market and business forces happening around you. It provides you with ongoing, ever-evolving early warning signals that let you evaluate your plan in the wake of those forces, to determine whether you’re still on the path to achieving your mission, or if you need to make adjustments to course correct. It also helps you identify whether changes are a product of oversights in your plan or bigger market forces—and whether those market forces are temporary hurdles you need to overcome or more permanent shifts that need more attention.

Why Is Having an Early Warning System Important?

As a financial professional, an early warning system can help you get on top of change before it significantly impacts your business, to align your team and data early and make shifts as necessary. It involves regular reviews of leading and lagging indicators and identifies your organization’s vulnerabilities to build agility and resilience into your planning process. By putting a standardized process in place, it lets you stay ready for change—and gives you the tools you need to deal with it when it inevitably arrives.

Examples of Leading and Lagging Indicators

Leading and lagging indicators are key to an early warning system and can help you better understand your business and the market around it—both where it’s been and where it’s going. By identifying the leading and lagging indicators important to your business and watching them closely, you’ll be able to act with more agility and determine your best response early while you still have time to plan and the room to make adjustments as needed. They each play a different role:

  • Leading indicators are those KPIs or metrics that are most likely to change before any large-scale market or business changes happen. They can be used to demonstrate future trends before any financial output of business shifts become evident and inform course corrections early. While leading indicators aren’t 100% accurate, they’re critical to any kind of early warning system. Examples might include traffic, demand, website visits, impressions or trending hashtags. Customer or employee satisfaction—as predictors of customer loyalty and retention or company performance and turnover—can also be leading indicators. Together, these types of metrics can give you a picture of what the future might hold.
     
  • Lagging indicators, meanwhile, are the opposite. Otherwise known as trailing indicators, they’re like a rearview mirror looking back at where you’ve already been. That may not seem as critical to an early warning system meant to predict change, until you realize that you don’t—and can’t—get everything right all the time. Sometimes plans go wrong and having an eye on the past lets you understand whether you achieved the results you were looking for—and if not, why. All of which helps you prepare for the future and build a better plan. Lagging indicators might include revenue, profit and growth. And since those are things you’re already measuring and comparing with others in your industry, it’s not much of a leap to start looking at where you’re faltering to determine where you’re most vulnerable to change.

Together, leading and lagging indicators provide a picture of your company and how it fits into the market around it as well as the trends emerging around the corner. In doing so, they help you recognize where your business might be affected so that you’re ready to roll with any changes. But for that to happen, you need ways to review, understand and deal with those new changes with agility and confidence, along with a regular process that keeps the entire idea of change top of mind.

Operational vs. Financial Reviews

Change has a way of sneaking up on you if you aren’t keeping a close enough eye on it. This is why regular operational and financial reviews are also critical to an effective early warning system. Through monthly or even weekly reviews—with up-to-date dashboards that help you share and visualize the metrics you’re looking at—you’ll be able to stay on top of new trends and identify how your business may be vulnerable to them. You’ll also be able to keep key stakeholders informed and on board with your plans.

  • Operational reviews allow you to look at the bigger picture business concerns around your operating procedures, product or service operating margins, product profitability, communication and so on. This type of review will help you identify yellow and red flags related to lagging and leading indicators, such as customer and employee satisfaction, product pipeline or brand recognition. Operational data can be especially effective in providing early warning signals, offering a view into future sales and revenue.
     
  • Financial reviews, on the other hand, consider such things as profit and loss as well as budgets and forecasting. They also look at lagging indicators that include revenue and growth. This is where you might also consider market indicators—for instance, stock market performance, currency strength or unemployment numbers—and how they might affect your business.

The right processes—including scenario modeling—can help you plug all of those metrics in to see what the future could hold and how well you’re situated to navigate any changes ahead.

A Plan For Changing Course

Understanding leading and lagging indicators isn’t enough if you don’t have the processes in place to leverage those indicators and create a plan around them.

That starts with scenario modeling. While Vena’s benchmark report shows that 40% of organizations aren’t using scenario modeling, it’s a powerful way to plug in the trends you’ve identified to see what your organization’s possible futures might look like in the face of them. By putting those possible futures together with your actual past—the rearview mirror view your lagging indicators offer—you’ll be able to get a full understanding of how future scenarios might affect your organization as a whole and how to make the adjustments you need to thrive.

Identifying any necessary plan adjustments or decisions that need to be made will also require agile planning processes such as cash flow management and agile forecasting. It also involves a solid foundation of data—and the power of data-driven storytelling—every step of the way.

By incorporating an early warning system and making it a systemic, repeatable and leaned upon way of doing business, you ensure you’re always ready for what’s ahead and also prepared to react quickly to whatever happens. While change may seem unpredictable and impossible to handle, it’s not insurmountable. With an early warning system, it becomes just another part of doing business—and one more thing the finance team is empowered to navigate as you lead your organization today and into tomorrow.

Download your free copy of the Vena Q2-2020 Industry Benchmark Report today, and find out how you can turn your data into a direction with Vena agile planning.

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