What are performance indicators?accounting ratio and its interpretation
A performance indicator refers to any piece of information that serves the purpose of measuring or indicating the level of performance or success achieved by an activity, group of people, or facilities. Performance indicators generally consist of quantitative information rather than subjective descriptions such as "good" or "bad".
Performance indicators are used not only in accounting, but every type of information systems. For example, a maintenance management may use a performance indicator such as "mean time between failures" to measure performance how ell the maintenance function is able to reduce machine failures.
In accounting the most commonly used performance indicator is profit. But for effective management in an organization we need to measure performance of not just the final result such as the profit but also of activities that contribute and lead to the final profit. Thus we may need to measure performance of activities such as purchase, production, inventory, manpower productivity, capital cost, maintenance cost, and so many others. Depending upon what activities needs to be planned and controlled more closely we need to develop and choose appropriate performance indicators.
In addition, to choosing the right areas to be covered by performance indicators, it is also necessary to design the most appropriate way of measuring performance in a given area. One very technique used to improve the utility of performance indicators is to use ratios. For example, though a manager is very much interested in knowing the total profit earned by the unit managed by him or her, this information alone is not enough decide if this profit is adequate or not. A small profit of half a million dollar on a sales turnover two million dollar may mean better performance than a larger profit of one million dollar earned on ten million dollars. The ratio enables us to compare and contrast meaningfully different things. It is like being able to compare meaningfully apples with oranges.
One of the most commonly used performance indicator using the concept of ratio is "efficiency". In accounting, it is possible to develop and use many more useful ratios. Some of the other commonly used ratio include, margin of profit on turnover, rate of return on capital employed, and inventory turnover ratio.