FRSA

Unit 3:
Performance Indicators and Their
Analysis
Unit 3: Performance Indicators and Their Analysis

Introduction

This unit is designed to help learners in acquiring knowledge on various performance indicators used in analyzing the overall
performance of the company.

The unit discusses about the reliability of performance indicators in the valuation of the company.

Some of the important statements such as profit and loss account such as gross sales, net sales, retained profit, direct and indirect
expenses have been analyzed with real-time examples.

2
Unit 3: Performance Indicators and Their Analysis

Learning Objectives

At the completion of this unit, you will be able to:

• Explain the concept of accounting practice and financial statements.
• Identify the users of financial statements and their information requirements.
• Demonstrate an understanding of accounting standards.
• Analyse the information contained in financial statements and explain the components.

3
Unit 3: Performance Indicators and Their Analysis

Table of contents

S.No Details Page No.

1. Introduction to Performance Indicators 6
2 Reliability of Performance Indicators 7
3 Sales 8
3.1 – Gross Sales 9
3.2 – Net Sales 11
4 Cost of Production 14
5 Cost of Goods Sold 16
6 Gross Profit 19
7 Operating Profit 21
8 Profit before Tax (PBT) 22
9 Profit AfterTax (PAT) 25
10 Retained Profits 27
11 Inventory Valuation 31

4
Unit 3: Performance Indicators and Their Analysis

Table of contents

S.No Details Page No.

11.1 - First in First Out (FIFO) 33
11.2 – Last in First Out(LIFO) 33
11.3 - Weighted Average Cost 34
12 Expense 35
12.1 – Direct Expense 35
12.2 – Indirect Expense 35
12.3 – Non operating Income 35
12. 4 – Non operating Expense 36
13 Summary 37
14 Reference 38
14.1 – Web Reference 38

5
Unit 3: Performance Indicators and Their Analysis

1. Introduction to Performance Indicators

A popular saying goes, “If you can’t measure it, you can’t improve it”.
The same holds true with any business firm which runs operations with the main intention of generating profits.
In order to understand what needs to be improved, the business must understand what the goals are and what is the current level of
performance is so that it is easy for the company to understand the direction of a journey.
The performance indicators come handy in helping companies to measure the performance.
The performance indicator is a ratio, rate, percentage or a proportion that indicates the performance of an organization in relation to a
specific outcome.
There is a wide range of performance indicators used by business firms.
The performance indicators help decision makers in the process of
decision making.
Given that, gross sales, net sales, cost of production, cost of goods sold,
gross profit, net profit and other aspects are the lifeblood of the business
and an analysis of these reports is critically important to survive in the
competitive world.

6
Unit 3: Performance Indicators and Their Analysis

Lack of transparent records and vague ideas on the current financial position on the business may lead to failure and other serious
consequences.
Performance indicators are a set of quantifiable measurement tools that a business enterprise uses to measure the performance over a
period.
These tools are used to trace the company’s progress in terms of achieving it's operational as well as the strategic goals and, also these
tools help a company to compare its performance within the same segment or industry.
For example, a Fast-Moving Consumer Goods (FMCG) company’s goal might be to stimulate the speed of growth within the industry.
Profit, Revenue, Cost and Cash flows are critical performance measures that are used by the companies. The performance indicators
may change from industry to industry. It depends on the operation cycle or nature of business or industry.

2. Reliability of Performance Indicators

There is no standard equation available in choosing a performance indicator. It can be chosen based on historical experiences.
Management are sometimes anxious about the reliability of the performance indicators.
However, experience shows stakeholders are more concerned about the trend than about the absolute numbers.
Hence, performance indicators still retain their prominence in financial statement analysis.

7
Unit 3: Performance Indicators and Their Analysis

Nowadays, financial reports necessarily include performance indicators in financial reporting. This is to enable readers to understand the
company’s strategies and its potential to outperform in the market.
However, it is important for a company to keep its measurement indicators in line with goals and objectives. And, it is important for
management to justify the indicators chosen for the analysis of its financial reports.

3. Sales

Sales are a critical activity for any business. No matter how big the company is?
How sophisticated the company is? How tight the financial goals are. If the
sales figure is not strong, rest everything is of no use for an organization.
No business will survive if the sales figure is stagnant or moving downward over
the period.
Sales pump revenue to the business which in turn brings profit, which is the
ultimate objective of any business.
Sales are categorised as:
• Gross Sales
• Net Sales

8
Unit 3: Performance Indicators and Their Analysis

3.1 - Gross Sales

Gross sales are also termed as “top line” of business. Gross sales are the total of all
the transactions or events occurred during a period that hasn’t been adjusted
against any expenses or cost.
Gross sales reflect the amount of product or service that a business sells in a period
relative to its competitors in the industry.
Gross sales are calculated by adding the values of all the invoices for products and
services that have been sold.
Gross sales must be watched over a period to draw a pattern of its progress. Gross
sales are important because it explains how much money is flowing into the
company by sales and sales related activities.
When the sale happens, it will be recorded as gross revenue regardless of whether
the income is received during the period or not.
However, Gross sales are misleading sometimes. The company, which is generating
a substantial value of gross sales, may not be able to find the surplus after all the
adjustments including the debt and equity obligations.

9
Unit 3: Performance Indicators and Their Analysis

Hence, in the corporate world, less prominence is given to gross sales while interpreting the financial reports of a business due to its
inherent limitations. Gross sales only show the trend in which sales number is changing.
However, the gross sales are unable to explain how these numbers are achieved and how the organization has played a role in
generating that numbers.
Further, it is important to understand that the gross sales are different from revenue. Gross sales are only one component of revenue.
Gross sales are simply the sum of all the amounts generated out of sales.
But revenue is a broader term which demonstrates the company’s ability to generate money within the business.
Revenue is the income generated by a business from all the sources which are linked to an organization. Below is an illustrative example
of Maruti Suzuki for the period of March 2018.

Maruthi Suzuki India

In Rs. Cr.
Standalone Profit and Loss Account Mar 18 Mar 17 Mar 16 Mar 15 Mar 14
12 mths 12 mths 12 mths 12 mths 12 mths
INCOME
Revenue from Operations (Gross) 80,336.50 76,140.80 63,957.70 53,768.50 47,822.80

10
Unit 3: Performance Indicators and Their Analysis

Maruthi Suzuki India

Less: Excise/ Service tax/ other levies 2,231.70 9,231.40 7,516.50 5,163.00 5,178.00
Revenue from Operations (Net) 78,104.80 66,909.40 56,441.20 48,605.50 42,644.80
Other Operating Revenues 1,657.90 1,125.40 1,096.90 1,365.10 1,055.80
Total Operating Revenues 79,762.70 68,034.80 7,538.10 49,970.00 13,700.60
Other Income 2,045.50 2,300.10 1,461.00 831.60 822.90
Total Revenue 81,808.20 70,334.90 58,999.10 50,802.20 44,523.50

3.2 - Net Sales

Net sales are also called as, “bottom line”. The net sale is an amount generated by a company after the deductions and provisions for
damaged/missing goods and discounts allowed.
The deductions are made from the gross sales and arrived at the net sales value. Hence, the net sales value is considered as a more
credible source while analysing the financial reports of a business.
Below mentioned items must be identified while calculating net sales.
• Total sales.
• Sales return.
• Damaged inventory/Missing inventory.
• Discounts allowed.
11
Unit 3: Performance Indicators and Their Analysis

Example
Let us assume that Karamchand Enterprises sell Wall Clocks. The business had sold Rs. 2,00,000 worth of wall clocks.
Due to unexpected reasons, Rs. 10,000 worth wall clocks had returned to the business and Rs. 5,000 worth inventories were damaged
and Rs. 2,000 worth inventories were missing.
Karamchand Enterprise has given the trade discount of Rs. 5,000 to its customers. Calculate the net sales for the Karamchand
Enterprises.
Solution
Gross sales = Rs. 2,00,000
Sales returns = Rs. 10,000
Damaged goods = Rs. 2,000
Trade discount = Rs. 5,000
Net Sales = Gross Sales - (Sales Returns + Damaged Goods + Trade Discounts)
Net Sales = 2, 00,000 – (10,000 + 2,000 + 5,000)
Net Sales = Rs. 1, 83,000

12
Unit 3: Performance Indicators and Their Analysis

Below is an illustrative example of Maruti Suzuki for the period of March 2018.

Profit and Loss account of Maruthi Suzuki India

In Rs. Cr.
Mar 18 Mar 17 Mar 16 Mar 15 Mar 14
Standalone Profit and Loss Account 12 mths 12 mths 12 mths 12 mths 12 mths
Income
Sales Turnover 81,994.40 77,266.20 65,054.60 55,133.60 48,878.60
Excise Duty 2,231.70 9,231.40 7,516.50 5,163.00 5,178.00
Net Sales 79,762.70 68,034.80 57,538.10 49,970.60 43,700.60
Other Income 2,032.40 2,290.10 1,454.90 831.60 822.90
Stock Adjustments -40.70 380.10 -6.90 455.90 -18.50
Total Income 81,754.40 70,705.00 58,986.10 51,258.10 44,505.00

13
Unit 3: Performance Indicators and Their Analysis

4. Cost of Production

Cost of production is the expense incurred in procuring goods or services.

A company which is aware of how much it is spending to produce goods or services will have better clarity on for which price the product
or service to be sold and what would be the expected profit.
The cost incurred during the production can be classified into two broad categories.

• Fixed Cost • Variable Cost

• Fixed costs are also known as overheads. Fixed costs are those costs which do not change with the output produced.
For example, the expenses like rent, insurance, depreciation remain the same irrespective of the level of production.
• Variable costs are those which will change with the changes in the level of output.
For example, expenses like the cost of raw material, labour, telephone and internet charges changes if there is any change in the
level of production.

14
Unit 3: Performance Indicators and Their Analysis

15
Unit 3: Performance Indicators and Their Analysis

• Sunk Cost:
Sunk costs are those costs which cannot be recovered if a company becomes bankrupt. For example, marketing and advertising costs.
Many times sunk costs are considered as barriers to entry and exit. Performance indicators are useful because it:
• Helps to make better decisions
• Helps to improve the focus in the future
• Helps to keep the activities consistent
• Helps to identify cost-saving opportunities
• Helps to convince potential clients

5. Cost of Goods Sold

Cost of Goods Sold (COGS) are also called as the cost of sales is an accounting calculation that measures the number of expenses that
directly flows into the efforts of manufacturing or producing goods or services.
In other words, cost of goods sold is the money the business spends on materials, labour and overheads to produce a product or service.
COGS is a direct cost of producing a product or service. Direct cost includes only materials, labour and overheads. Without these
elements, business would not have produced a product or service.

16
Unit 3: Performance Indicators and Their Analysis

There are certain expenses which do not have a direct impact on the manufacturing or producing a product or service. These expenses
are called indirect expenses.
For example, advertising expenses and promotional campaign expense. The easy way to calculate COGS is to consider inventory at the
beginning of the period, add the total value of purchases during the period and deduct the closing value of inventory.

COGS = Beginning Inventory + Purchases during the period – Closing Inventory

Example:
If a company starts a business with Rs. 10,00,000 inventories, purchases the inventory worth of Rs. 2, 00,000 and ends business with
the inventory worth Rs. 5, 00,000. The cost of goods sold for the period can be calculated below:
Solution
COGS = Rs. 10, 00,000 + Rs. 2,00,000 – Rs. 5,00,000 = Rs. 7,00,000
The cost of goods sold is reported in the income statement and considered as an expense for the period. The main reason why COGS is
crucial for the stakeholder is that it is directly linked to the gross profit of the company.
COGS can be subtracted from the total revenue of the company to obtain the company’s gross profit.

17
Unit 3: Performance Indicators and Their Analysis

This helps the stakeholder to know how profitable the company is and how the business is run over a period.
Calculation of COGS is also useful to compare the price of its product against the cost associated with producing the same. If the pricing
is lower than COGS, it’s a trouble for the company.
There should be some money left over after deducting all the direct expenses. But direct expenses cannot be the sole determinant of
profit for a business, because indirect expenses also need to be deducted, to find out the profit generated by the business.
However, COGS can be considered as a first level check to understand whether the pricing is able to generate profit.
The calculation of the cost of goods sold differs from business to another. In manufacturing firm COGS includes material, labour and
overheads. In the wholesale trading business, the cost of goods sold is mostly from the merchandise that was received from the producer
of the product.
Service industry, on the other hand, has less identity. The cost of goods sold will be significant in product-based business entities. Many
service business entities do not have the cost of goods sold.
This is because service companies do not have any goods to sell. Since, there are no goods to be sold, then no point in deducting COGS
from total sales.
However, in the service industry, the appropriate term to be used in the place of COGS is cost of service. For example, Hotels, Hospitals,
Consultancies, Real estate agencies, etc.
Even though all these entities have business expenses, they are listed below the cost of service and not below COGS. However, many
service business entities have got products to sell.

18
Unit 3: Performance Indicators and Their Analysis

6. Gross Profit
Gross profit is the total revenue of a business less cost of goods sold. Gross profit is also called as gross margin or gross income. Gross
profit measures the ability of the company to use its labour and supplies.
Gross profit will be available on the income statement and can be calculated as shown below:

Gross Profit = Revenue – COGS

Or
Gross Profit = Revenue – (Direct material + Direct labour + Overhead)
Example
The following data relates to a business enterprise. From the data given below calculate the gross profit.
Particulars Amount (Rs)
Gross sales 10,00,000
Sales returns 50,000
Opening stock 3,00,000
Purchases 4,50,000
Purchases returns 40,000
Closing stock 50,000
19
Unit 3: Performance Indicators and Their Analysis

Solution:
Particulars Amount (Rs) Amount (Rs)
Sales 10,00,000
Fewer Sales Returns -50,000
Net Sales 9,50,000

Less: Cost of Goods Sold (COGS)

Opening stock 3,00,000

Purchases +4,50,000
fewer purchase returns -40,000
Inventory available for Sale 7,10,000
Less Closing Stock -50,000
Gross Profit 6,60,000
Generally, banks check gross revenue of the clients in order to understand the size of the business. Further, it shows the core activities
of the business to the management.
20
Unit 3: Performance Indicators and Their Analysis

7. Operating Profit

Operating profit is the income generated by the core operations of the business. Operating profit excludes tax and interest components.
Operating profit is also called as Earning before income and tax (EBIT) or operating income. In other words, operating income is the
revenue generated by the business after all its general purposes and administrative expenses but excludes tax and interest obligations.
The term operating profit indicates that, the cost associated while running a business. Operating profit is helpful to understand the
company’s ability to control the costs of its operations.
The information on operating profit is also useful to measure the performance of a business over a period. If the EBIT is negative, it
indicates the business requires an additional external funding to continue its operations.
Sometimes, companies tend to highlight operating profit instead of displaying net profit for the period. This is because the tax and interest
expenses are high. So, the net profit is likely to be low.
Example:
Delicate Fashion designers has a revenue of Rs. 10 million,
Cost of goods sold = Rs. 3 million
Administrative expenses = Rs. 2 million
Interest expenses = Rs. 2 million
Tax expenses = Rs. 4 million
21
Unit 3: Performance Indicators and Their Analysis

Solution
In this example, net profit turns out to be Rs. 1 million (negative returns). However, operating profit is Rs. 5 million (positive returns).

8. Profit before Tax (PBT)

Profit before tax is the profit generated by a business after paying all its
obligations, including operating and administrative expenses, interest
expenses except income tax.
Profit before tax is also called as Pre-tax income or Earning before tax.
Profit before tax is useful because the tax components are constantly
changing.
It is advisable for a stakeholder to analyse the financial reports of a
company without considering the tax component.
Because a few industries or geographical regions may receive tax
concessions while others are not.
This may bring change in the net income of a business.

22
Unit 3: Performance Indicators and Their Analysis

Example
Below is an illustrative example of Rajath Ltd.

Details Amount (Rs)

Sales Revenue 20,00,000

Operating expenses 10,00,000

Earnings before taxes 10,00,000

Income tax expenses 5,00,000

Net earnings 5,00,000

Profit before tax gives a clear picture of how a company is performing within a segment. This analysis can be carried out only when the
comparing companies are from a similar business and same industry.

23
Unit 3: Performance Indicators and Their Analysis

Below is an illustrative example of Maruti Suzuki for the period of March 2018.

Maruthi Suzuki India

In Rs. Cr.
Profit before Tax Mar 18 Mar 17 Mar 16 Mar 15 Mar 14
12 mths 12 mths 12 mths 12 mths 12 mths
Depreciation and Amortisation Expenses 2,757.90 2,602.10 2,280.20 2,470.30 2,084.40
Other Expenses 9,991.50 8,724.10 8,037.70 6,643.10 5,922.10
Less: Inter unit/Segment/ Division Transfer 99.10 103.60 60.20 69.10 34.30
Total Expenses 70,804.80 60,374.60 51,555.40 45,934.00 40,865.00

Profit/Loss Before Exceptional 11,003.40 9,960.30 7,443.70 4,868.20 3,658.50

Extraordinary Items and Tax
Profit/Loss Before Tax 11,003.40 9,960.30 7,443.70 4,868.20 3,658.50

24
Unit 3: Performance Indicators and Their Analysis

9. Profit After Tax (PAT)

Often company’s total earnings do not reveal the true financial condition of a business. Sometimes, even when the top line is flying, the
bottom line will be dying.
For example, a company may put a lot of efforts to increase sales, but there is no meaning in doing so if the cost is also increasing. That
will eat up the margins. This is a clear indication that the company is in the need of an efficient cost-controlling mechanism.
Profit after tax (PAT) is an income earned by a business after meeting all its obligations, including operating expenses, interest and tax
expenses. Profit after tax is also called as Net Operating Profit after Tax (NOPAT) or Bottom line.

PAT can be fully retained and utilized by a company for internal

purposes, including paying dividends to the shareholders.
PAT is closely observed by investors while taking investment decisions.
By observing the trend of profit after tax year on year, the investor may
get an idea of how the company would perform in the future.

25
Unit 3: Performance Indicators and Their Analysis

Below is an example of Profit after tax values for Maruti Suzuki for the period of March 2018.

Maruthi Suzuki India

In Rs. Cr.
Mar 18 Mar 17 Mar 16 Mar 15 Mar 14
Profit after Tax 12 mths 12 mths 12 mths 12 mths 12 mths
Profit/Loss Before Exceptional
11,003.40 9,960.30 7,443.70 4,868.20 3,658.50
Extraordinary Items and Tax
Profit/Loss Before Tax 11,003.40 9,960.30 7,443.70 4,868.20 3,658.50

Tax Expenses - Continued Operations

Current Tax 3,349.50 2,335.60 2,041.40 1,302.60 747.90
Less: MAT Credit Entitlement 0.00 0.00 0.00 70.40 0.00
Deferred Tax -67.90 274.50 38.00 -75.20 127.60
Total Tax Expenses 3281.60 2,610.10 2,079.40 1,157.00 875.50
2,Profit/Loss after Tax and before
7,721.80 2,350.20 5,364.30 3,711.20 2,783.00
Extraordinary Items

26
Unit 3: Performance Indicators and Their Analysis

10. Retained Profits

Retained earnings refer to the number of net earnings not paid out as dividends but retained by the business enterprise to be reinvested
in profitable business opportunities.
In other words, retained earnings are the profit generated by the business that is not distributed to the shareholders as dividends, but
retained or reinvested in the business.
When a company earns a profit, the same can be spent in two important ways.
• Profit can be distributed among shareholders to the proportion of their holdings in the company.
• Profit can be retained by the company to invest in profitable business opportunities.
When a company declares a profit for a period, the share prices will move dramatically. This may be because of growth in sales,
Earnings per share (EPS). But apart from these factors, there is a factor which will affect the share price.

27
Unit 3: Performance Indicators and Their Analysis

Warren Buffet’s view on Retained Earnings

In 1984, Warren Buffett made the below comments:

“Unrestricted earnings should be retained only where there is a reasonable prospect – backed preferably by historical evidence or, when
appropriate by a thoughtful analysis of the future – that for every dollar retained by the corporation, at least one dollar of market value
will be created for owners. This will happen only if the capital retained produces incremental earnings equal to, or above, those generally
available to investors”.
Source: http://www.buffettsecrets.com/retained-earnings.htm

According to warrant buffet, ability to use retained earnings wisely is a good sign of a
strong management.
If the company is unable to use the earnings in a better way, it is better to distribute the
earnings in the form of dividends by that the business can create value for its shareholders.
Moreover, using retained earnings profitably will not solely serve the purpose. Retained
earnings must increase substantially.
After all, leaving the earnings in a saving account will increase earnings with zero efforts.

28
Unit 3: Performance Indicators and Their Analysis

For a business, retained earnings are a good source of funds for expansion of the project, investment in research and development.
Business can create value for its shareholders by using the retained earnings appropriately.
This component is recorded under the owner’s equity on the balance sheet.
Example:

Airtel Limited’s retained earnings for the period of 31st March 2016 are shown below:

As at As at
Particulars Notes No.
31.03.2018 31.03.2017
EQUITY AND LIABILITIES
Equity
Issued capital 32 19,987 19,987
Treasury shares 32 (524) (114)
Share premium 123,456 123,456
Retained earnings 517,082 473,025
Other reserves 32 (3,700) 3,210
Equity attributable to equity holders of the parent 656,301 619,564
Non-controlling Interests 51,984 48,525
Total Equity 708,285 668,089
29
Unit 3: Performance Indicators and Their Analysis

It is important for stakeholders to understand about the retained earnings. It is not just about how much the company is earning and how
much has been spent and what is left over with the company after meeting its entire obligation.
Rather, retained earning demonstrates how company generated value out of its obligations. Retained earnings can be used either for the
purchase of assets or for the reduction of liabilities.
Below is an illustrative example of retained earnings of Maruti Suzuki for the period of 31st March 2018.
Year ended on Year ended on
Retained Earnings
31.03.2018 31.03.2017
Balance at the beginning of the year 313,189 5250,037
Profit for the year 77,218 73,502
Addition due to amalgamation - 2,475
Other comprehensive income arising from remeasurement of defined
(131) (100)
benefit obligation
Payment of dividend on equity shares (22,656) (10,573)
Tax on dividend (4,612 (2,152)
Balance at the end of the year 363,008 313,189
However, there is a dark side for the story. If the retained earnings are not utilized efficiently and remain unutilized, then the same
retained earnings may destroy shareholder’s value.
30
Unit 3: Performance Indicators and Their Analysis

11. Inventory Valuation

In financial accounting, inventory means the stock of raw materials, work in progress and finished goods that are considered as the part
of the business’s assets and will be ready for sale.
Inventory is considered one of the most essential assets for a business because inventory turnover is one of the major sources of
revenue for a business.
According to Accounting Standard (AS2), Inventories are assets:
a. Held for sale in the ordinary course of business;
b. In the process of production for such sale; or
c. In the form of materials or supplies to be consumed in the production process
An adequate management of inventory for the business is as good as an investment decision. Because, the level of inventory held in the
business may have a direct impact on the working capital, assets and profit margin of a business.
In fact, regulatory authorities allow companies to use different inventory valuation techniques for tax reporting purpose. The company
must be careful while choosing the inventory valuation technique for the business.
While scrutinizing the balance sheet, attention must be paid to the company’s current assets. Further, the analyst should check the level
of inventory for the period.

31
Unit 3: Performance Indicators and Their Analysis

Inventory is recorded under current assets since it can be converted into cash within one year.
Carrying adequate inventory for the business is essential for a business. If the company’s inventory is increasing over a period, this can
be the red flag for a business.
This is because the increasing level of inventory may mean the company is struggling to clear the inventory, blockage of working capital,
increasing idle resources, increasing the cost of handling inventory, chances of goods getting obsolete, etc.
This may also lead to the opportunity cost for the business. On the other hand, if the inventory level is low, this may damage the
reputation of the business.
This is because; the business may fail to meet the rising demand for the product in the market. So, striking the right balance between
both is always challenging.
Hence, analysing the details related to inventory is critical for the stakeholders of the business. The level of inventory in the business
should be measured by comparing the values of multiple years or comparing with the other companies in the same industry.
There are basically three important methods to value inventory.

• First in first out (FIFO) • Last in first out (LIFO) • Weighted average method

32
Unit 3: Performance Indicators and Their Analysis

11.1 - First in First Out (FIFO)

The First in First Out (FIFO) method explains that the items of inventory which
were purchased or produced first are used or sold first, and consequently, the
items remaining in inventory at the end of the period are those most recently
purchased or produced.
For example, using the refrigerator at home could be the right example to
understand the FIFO Method.
For example, assume you have brought some fruits to home. You
subconsciously replace the oldest fruit which was kept in the refrigerator earlier.
First, you wish to consume the fruits which are already there in the refrigerator
and the next priority will be given to the fruits which you have purchased recently.
This best explains the FIFO concept.

11.2 - Last in First Out (LIFO)

Last in First Out method (LIFO) is simply the opposite of First in First Out (FIFO). Instead of oldest inventory being considered as sold
first, the newest product should be sold first.
For example, if you visit a bakery to buy the bread, you will prefer to buy the bread which is prepared recently (Prepared just hours
before). So, the owner of the bakery would prefer lower inventory since the demand for the old stock will be lower in his business.
33
Unit 3: Performance Indicators and Their Analysis

11.3 - Weighted Average Cost Method

Under the weighted average cost method, the cost of each item is calculated from the weighted average of the cost of similar items at the
beginning of a period and the cost of identical items purchased or produced during the period.
The average may be determined on a periodic basis, or as each additional shipment is obtained, depending upon the circumstances of
the enterprise.
However, as per accounting standard 2 of ICAI (AS2) only First in first out (FIFO) and weighted average cost of capital methods is
allowed. Companies are prohibited from using the LIFO method due to its inherent limitations.
Last in first out method (LIFO) which was permitted under Generally Accepted Accounting Principles (US GAAP) is prohibited under
International Financial Reporting Standards (IFRS).
After the revision of Indian Accounting standard 2 in 2003, the LIFO method was officially prohibited by the companies which are following
Indian Accounting Standards while preparing the financial reports.
This is because companies may intentionally adopt the LIFO method for the valuation of their inventory. This is to exploit the opportunities
which arise due to inflation. In inflationary situations, the LIFO method helps companies in terms of tax reduction.
This is possible because, the LIFO method assumes that the inventory bought latest will be sent to the production room first and
consumed earlier and thus higher value inventory will be included in the cost of sales which will result in a larger cost of production and
hence, lesser tax burden.

34
Unit 3: Performance Indicators and Their Analysis

12. Expenses

12.1 - Direct Expenses

Direct expenses are the expenses which can be conveniently allocated to a cost centre, cost unit or a job. In other words, expenses
which are completely related to the core business operation are direct expenses.
For example, Wages, Factory rent, Material cost, Fuel, Freight, etc.

12.2 - Indirect Expenses

Indirect expenses are not directly linked to the core business operations. Though, indirect costs are not directly connected to the core
business operations, these expenses are inevitable to keep the business going.
For example, Telephone charges, Salaries, Legal and Accounting charges, etc.

12.3 - Non-operating Income

Non-operating income is the income generated by a business other than the core business operations. Non-operating income is also
called as incidental income.
Because there is no certainty on the gain by these sources and this does not occur on a regular basis. While analysing the annual
reports of a company it is necessary to categorize the income into operational and non-operational profit/loss.

35
Unit 3: Performance Indicators and Their Analysis

For example, if a company’s earnings per share (EPS) is slightly higher than the last year which is due to one-time earning from
investments. This need to be excluded from the company’s operating income in order to have better clarity on the financial results of a
company. For example, Dividend income, Interest income, Income from investments, Foreign exchange etc.

12.4 - Non-operating Expenses

Non-operating expense is an expense incurred by a company that is unrelated to its core business operations.
For example, a company may let out its unused office space for rent. Letting out additional building space generates revenue. This
income is considered as non-operating income.
The amount the company spends on the maintenance of this property can be considered as non-operating expenses. For example,
Repair expenses, Property tax, Supervisor’s salary etc.

36
Unit 3: Performance Indicators and Their Analysis

13. Summary
Here is a quick recap of what we have learned so far:
• Performance indicators are a set of quantifiable measurement tools that a business enterprise uses to measure its performance over
a period.
• Gross sales are the grand total of all the transactions occurred during a period that hasn’t been adjusted against any expenses or
cost. Gross sales reflect the amount of product or service that a business sells relative to its competitors in the industry.
• The level of inventory in the business should be measured by comparing the values of multiple years or comparing with the other
companies in the same industry.
• Retained earnings refer to the number of net earnings not paid out as dividends but retained by the business enterprise to be
reinvested in profitable business opportunities.

37
Unit 3: Performance Indicators and Their Analysis

14. References
• Narayanaswamy, R. (2005). Financial accounting a managerial perspective. New Delhi: Prentice-Hall of India.
• S. Maheshwari - S. Maheshwari - D. Maheshwari – Vikas (2010) Financial Accounting. Publishing House Pvt. Ltd.
• Rawat, D. S. (2013). Students' guide to accounting standards. New Delhi: Taxmann Allied Services.
• Tulsian, P. C. (2010). Tulsian's financial accounting. S.l.: S Chand & Co.

14.1 - Web Sources

• Key Performance Indicators Are Not Just About Profit | CFMA. (n.d.). Retrieved August 02, 2016, from
http://www.cfma.org/content.cfm?ItemNumber=1899
• Performance Indicators. (n.d.). Retrieved August 2, 2016, from https://www.pwc.com/gx/en/audit-services/corporate
reporting/assets/pdfs/uk_kpi_guide.pdf
• Switzer Daily. (n.d.). Retrieved August 02, 2016, from http://www.switzer.com.au/the-experts/joe-kaleb-tax-expert/financial-
performance-indicators-for-businesses/
• Moneycontrol.com Company Info Print Financials. (n.d.). Retrieved November 22, 2018, from
https://www.moneycontrol.com/stocks/company_info/print_main.php
• Maruti Suzuki (n.d.). Retrieved November 22, 2018, from
https://marutistoragenew.blob.core.windows.net/msilintiwebpdf/MSIL_AR_2017-18_HR.pdf

38