Trend analysis is a technique for creating precise predictions based on historical data and analysis. It enables comparing data over a specific time frame and detecting uptrends, downtrends, and stagnation.
In financial statement analysis, trend analysis involves evaluating an organisation’s financial information over time. Depending on the situation, periods might be counted in months, quarters, or years. The goal is to calculate and analyse the amount of change and per cent change from one period to the next.
Financial statement analysis enables information analysers to identify percentage changes in the chosen data over time. It helps determine whether a company’s net profit is increasing, decreasing, or stable if there are variations over time.
Let us elaborate on trend analysis and some of its significant aspects.
An Overview of Trend Analysis in Financial Statement Analysis
Identifying trends in the data to make more accurate predictions is critical in any industry. Recognising these financial trends allows a company to understand your company’s accounting practices and improve financial planning and performance. The ability to identify market trends aptly can immensely benefit your investment strategy.
Within the financial industry, trend analysis is a broad term, as it uses multiple metrics and methods, including the horizontal analysis of financial statements and the technical trend analysis of stocks. Also, the results of other financial analyses like horizontal and vertical analyses, variance analysis, profitability analysis, etc., are often incorporated to provide more context for analysing these trends.
How Can Trend Analysis Help CFOs Make Insightful Decisions?
When chief finance officers (CFOs) take on the role of strategic leaders driving their company through quick decision-making, precise financial planning and analysis (FP&A), and forecasting can offer insightful recalibration of appropriate finance KPIs and apprehending the financial trends. CFOs can use it for various purposes, including price determination, demand forecasting, and investment decision-making.
Trend analysis requires financial data to evaluate a company’s performance and suggest how it might advance. Many organisations and CFOs are increasingly leveraging fintech cloud solutions, which provide a variety of data, including conventional (profits or expenses) and alternative data, for financial trend research.
In short, trend analysis provides a means to analyse company data over a period of time by focusing on the change in specific lines of items within the income statement and balance sheet. Therefore, collecting data from various periods is necessary for the trend analysis process, also known as time series analysis. The gathered data is then horizontally analysed and plotted to identify trends.
What is Horizontal Analysis?
Trend analysis in financial statement analysis is a statistical tool to show how certain elements have changed over time. The primary difference between vertical and horizontal analysis is that vertical analysis focuses on the relationships between the numbers in a single reporting period or one moment in time.
On the other hand, horizontal analysis is a method where financial statements are compared to reveal financial performance over a specific period of time. The comparative statement is then used to highlight any increases or decreases over that particular time frame.
This enables you to easily spot growth trends and any red flags that need to be addressed. As the horizontal analysis looks at trends over time on various items on financial statements, it is also referred to as trend analysis.
Advantages of Using Trend Analysis in Financial Statement Analysis
1. Inter-Company Comparisons
The analyst can properly compare two or more companies over time with the help of trend analysis, and it can also be contrasted with the industry standard. In other words, it helps to understand a particular company’s strengths or weaknesses compared to similar companies in the industry.
The management can make decisions based on trend analysis (in terms of percentages), which is considered more effective than mere numbers or data.
Therefore, trend analyses are constructive for comparing data to assess a company’s financial performance over time and to assist management in making decisions that will affect the future while predicting it.
2. Estimating Liquidity and Solvency
With the aid of related financial trend measures, trend analysis enables analysts and management to comprehend a company’s long-term solvency and short-term liquidity position over time.
3. Measuring Profitability Position
With the use of related financial trend ratios like the Operating Ratio, Net Profit Ratio, and Gross Profit Ratio, trend analysis also aids in measuring the profitability positions of an enterprise or a company through time.
A Few Disadvantages of Using A Trend Analysis
1. Selection of the Base Year
The base year must be chosen carefully. Typically, Any year can be used as the basis for a financial statement analysis. However, selecting a base year to identify the trend takes a lot of work to break down comparisons or trends accurately.
2. Consistency Issues
Following a consistent accounting principle and policy is also highly challenging, especially given how quickly commercial accounting trends switch.
3. Ineffective under Inflationary Conditions
Analysing trend percentages when prices change frequently is meaningless, especially during economic turmoil or inflation. Data trends that are used for comparison will produce incorrect results.
Closing Thoughts
Before a financial statement analysis, it’s essential to understand what type of trend analysis the company wants to perform. Choosing which market, sector, or asset to employ is the primary stage in the research. The company must also decide the period based on the goal and the relevant previous financial data.
The next step is to choose the type of trend analysis to perform and the platform to be used and confirm that the financial data needed is readily available.
The company can perform financial trend analysis using various management tools, such as Excel and cloud accounting software. However, modern solutions like Precisa’s Bank Statement Analyser are powerful tools that classify, verify, and analyse bank statements to detect irregularities or manipulations. Our analyser provides the most accurate results, improving your credit appraisal quality.
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