Financial statement trend analysis entails what?

Users of financial statements might benefit from a trend analysis by better understanding percentage changes in the chosen data over time.

Users can examine trends over time, such as whether a company’s net profit is growing, shrinking, remaining stable, or experiencing variations.

## Explanation

Changes from one year to the next can be simply incorporated into horizontal analysis of financial accounts. “Trend analysis” describes this method.

Changes over time are often evaluated for their potential to affect future performance by looking at how they’ve changed over a set period of time.

All annual reports contain a five-year overview of selected financial data, which can be helpful in this respect.

When looking at a time period longer than two years, index numbers should be utilized instead of percentage changes. Simply put, one year is picked as the base year, and its weight is set at 100%. The values for all other years are shown as a percentage relative to the base year.

Overall, utilizing the ideas and techniques of trend analysis, a person who is interested in measuring the earning capacity of a business can analyze sales and earnings for 3, 5, and 7 year periods.

The Index Number Formula

## Index numbers are determined by the following formula:

Amount in index year divided by amount in base year multiplied by 100 equals index number.

Users of financial statements can make important judgments with the help of trend analysis. Percentage shifts over multiple years, as opposed to only two, are the basis of trend analysis.

Users can determine if there is a problem or if there are evidence of effective management by looking at the trend for a specific ratio.

Here, index numbers are created with a specific year serving as the base year, with that year’s value of the depicted item equal to 100%.

Similar items from different years are compared to the base year’s value. The year chosen as the base for an index number should not be an outlier, hence care must be used when making this decision.

Instance 1

In 2015, Safeway reported $15,102,673,000 in revenue. The 2019 index year’s sales were $19,642,201,000. The following steps were taken to arrive at 2019’s index value of 130.06:

($19,642,201,000 – ($15,102,673,000)) x 100 = Index Number

= 130.06

In percentage terms, this means that Safeway’s 2019 sales were 130.06 percent more than the company’s 2015 revenues. In the same way, we can determine the index numbers for the remaining goods.

Interpretation

When trying to gauge actual expansion, index figures are invaluable. Sales at Safeway, for instance, climbed by a factor of 1.30 between 2015 and 2019.

It’s not really obvious if this indicates true sales growth, flat sales at higher prices, or something else entirely.

The sales growth index can be compared to the inflation rate over the same time period as a proxy for this.

One way to track inflation is through a price index, such as the All Urban Consumer Price Index or a sector-specific index.

Sales at Safeway must have increased for real between 2015 and 2019 if the index shows a 1.20x increase over the same time frame.

Instance 2

For the past five years, we’ve detailed Zenith Company’s sales and net profit below.

Here, we’ll do a trend analysis using 2014-2015 as our starting point.

Percentage Change in Trend: 2014-2015 as the Base Year for Calculation

The fiscal year of 2014-2015 serves as the baseline. Therefore, we split the sales and net profit figures for each of the four years (2015–16, 2016–17, 2017–18, and 2018–19) by those of the base year (2014–15). The percentage trend is then calculated by multiplying this number by 100.

## Interpretation

Sales and net profit have been on an upward trajectory, indicating a growth-oriented performance pattern. Net income grew at a faster rate than sales did, although only by a little margin.

Therefore, the company is a good investment opportunity.

When sales and net profit are both increasing, it is evident that net profit is increasing at a faster rate. Over the five years, revenues climbed by 100% while net profit increased by 181%.

A year-over-year comparison of sales growth and net profit margin reveals that

If sales climbed by 20% in 2015–16, net income would rise by 31%.

An increase of 40% in sales would result in a 56% rise in net profit for 2016–17.

For the 2017–18 fiscal year, a 67% rise in revenue would result in a 109% increase in net profit.

If sales climbed by 100% in 2018-2019, net income would rise by 181%.

The company’s management must be doing something right, as seen by this rapid expansion relative to the industry average.

Please keep in mind that although only positive growth is illustrated here, growth can sometimes be negative. In addition, stability can exist in the absence of either positive or negative development.