In this summary, we will cover

  • What is trend analysis?
  • What financial statements can be used to do trend analysis.
  • Why trend analysis is important.

Takeaways

  • There are various ways of performing financial statement analysis so as to gauge the financial health of a business. You can do a trend analysis, ratio analysis or a vertical analysis.
  • Trend analysis, which is also known as horizontal analysis is when you analyze the financial statements of a business over a period of time to determine the trend or movement of the various financial items such as assets and liabilities. The period can be in months, quarters, or financial years.
  • The goal of doing a trend analysis of a company’s financials is to evaluate the overall performance of the company as well as evaluating whether the management is performing as expected.
  • Among the many reasons why trend analysis is important, one of them is the fact that it helps management, and an investor or business owner to make strategic decisions. Knowing the various trends over a number of years gives you a chance to make an informed decision when it comes to the finances of the business. It could be increasing the revenues or expanding operations.

Trend analysis helps in identifying any accounting errors that may have happened over a period of years. Any extreme increases or decreases in accounting amounts should be investigated.

Summary

When it comes to gauging how a business is performing financially, financial statement analysis is what furnishes you with all the information you need. This means analyzing the statement of financial position, the income statement, the cash flow statement, and the statement of retained earnings. The main methods used in financial analysis are trend analysis, vertical analysis, and ratio analysis. Today we will concentrate on trend analysis- what it is, why it is important and how it gives clarity on key value drivers and constraints for a business.

Trend analysis also referred to as horizontal analysis is a financial statement analysis method used to show changes in the financials of a business over a period of time. You can choose to do a trend analysis over two years or more, or on different quarters of a financial year. The period of time is not really specific, but all depends on the amount of time you want to analyze. The main aim of trend analysis is to not only calculate the amounts and percentage changes over a period of time but to analyze them as well.

To calculate the amount of change e.g. of the operating income, you less the base year amount from the current year amount. The percentage change is calculated by subtracting the base year amount from the current year amount and dividing this by the base year amount.    i.e.

Amount of change= Current Year Amount- Base Year Amount

Percentage Change= (Current Year Amount- Base Year Amount) / Base Year Amount

For example, the operating income of Marriott International Inc. in fiscal years 2017 and 2016 was $2,359 and $ 1,368 (in millions). Taking 2017 as our current year, the amount of operating income change and the percentage change of the operating income of Marriott International Inc. will be as below:

Amount of change ($991) = $2,359 – $1,368

Percentage Change (72.44%) = ($2,359 – $1,368) / $1,368

This shows us that the operating income of Marriott International Inc. increased by 72.44% from 2016 to 2017. It is such a significant change for Marriott International and shows a positive performance of the company in the 2017 fiscal year.

This is just a one-off example. However, when performing a trend analysis for a business’s financials, you will have to evaluate each line item of the financial statements. If you were to analyze the statement of financial position of Marriott International Inc. figure one shown below, you will do a trend analysis of its cash and cash equivalent, and accounts and notes receivable, prepaid expenses, and assets held for sale.

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Figure 1

Current Assets 2017 2016 Amount Change Percentage Change
Cash & equivalents $383 $858 $-475 -55%
Accounts & notes receivable $1,991 $1,695 $296 17.46%
Prepaid expenses & others $224 $230 $-6 -2.6%
Assets held for sale $149 $588 $-439 -74.66%

Figure 2

From figure 2, above, we can see the movement of various current assets of Marriott International Inc. between 2016 and 2017 financial years. The cash and equivalents of the company decreased by $475 (-55%) change.

Whether you are doing a trend analysis over a two-year period or more than two years, the formula still remains the same.

Why is trend analysis important? One of the reasons why trend analysis is important is that it can be used in evaluating the performance of a company. By evaluating the changes and percentage movements of items, managers can gauge the performance of the organization and various departments. The trend will help stakeholders determine whether the business is deteriorating or improving in terms of its performance.

Trend analysis can also be used in making strategic decisions of the business. For example, if a trend analysis is done on the income statement of the company, and the expenses increase over the years whereas the sales are decreasing, then the management will notice. This will help them come up with better ways to increase sales and reduce the expenses, which in return will push up the net income. Through trend analysis, management has sufficient information to help improve or reduce the operations and profitability of the organization.

Any accounting variances will also be realized through trend analysis. When you compare financial data of different years, you are able to confirm whether there are any accounting variances such as omissions, errors or presentation of wrong data. As much as variances are expected in accounting data over a period of many years, extreme variances should be questioned and analyzed. From our examples above, it would be ideal to investigate why the cash and equivalents of Marriott International declined by 55%. Was it an accounting error or a management decision that lead to the decline?

References

Marriott International, Inc. 2017 Annual Report. (2018, February 14). Retrieved September 21, 2018, from https://www.google.com/search?q=marriot international 2017 financial report&ie=utf-8&oe=utf-8&client=firefox-b-ab#

https://saylordotorg.github.io/text_managerial-accounting/s17-01-trend-analysis-of-financial-st.html

https://smallbusiness.chron.com/importance-ratio-analysis-financial-planning-80600.html