Trend Analysis : an Important Tool of Analysis and Interpretation of Financial Statements

TREND ANALYSISTrend Analysis is also an important tool of Analysis and interpretation of financial statements. Trend means tendency in general term. The Comparative financial statements study changes which have occurred in each item of the balance sheet and profit and loss account within a period of two years but do not indicate the trend of progress during past years. Trend analysis discloses changes in the financial and operating data of financial statements between specific periods in relation to any past year called the base year and makes possible for the analyst to form an opinion about the favorable or unfavorable tendencies as reflected by the accounting data. This method of Analysis is immensely helpful in making Comparative Study of Financial Statements for several years.
The trend analysis of business operations and other financial data may be done in any of the following ways:-Trend Percentage Trend Ratios Graphic or Diagrammatic presentation
COMPUTATION OF TREND PERCENTAGEFinancial statements is tabulated and taking the earliest year or any one year as base , the percentage, increase or decrease for other years is calculated. The percentages are called trend percentages which give an idea about the changes in comparison to previous years. For example value of sales for the five years is given as follows:-

Year(31^st march) 2009 2010 2011 2012 2013

Sales (in Rs.) 1,50,000 1,80,000 1,30,500 1,65,000 1,87,500

   If we measure the changes in the sales value for other years taking 1999 as the base year the result will be as follows:-
TREND PERCENTAGE

31^ST March
Sales (Rs.)
Increase/decrease in comparison to 2003 Increase/decrease In% in comparison to 2003Increase/decrease×100Sales for the base year

2009 1,50,000 ----- -----

2010 1,80,000 + 30,000 +  20%

2011 1,30,500    -  19,500    -   13 %

2012 1,65,000 + 15,000 + 10%

2013 1,87,500 + 37,500 + 25 %

This shows percentage increase or decrease in the sale value in relation to the base year, but the method is not good in the sense that it contains plus (+) and minus (-) signs. It is better to convert all the items of the statements into percentages taking one year as base. They are also called trend ratios.
Precautions in Calculating Trend Percentages:-The base year should be selected carefully. It should be normal year free from any unexpected event.The accounting policies and practices should be kept consistent otherwise comparison will be affected adversely. Trend percentages should be studied after considering the absolute figures on which they are based. Otherwise they may give misleading results.It is better to adjust the current year’s figures in the light of the price level changes so that comparison may be realistic.
TREND RATIOSTrend ratio method is considered more suitable then this method. The calculation of trend ratio involves the arithmetical relationship which each item of several years bears to the same item of the base year. One particular year is taken as base and the value of each item is regarded equal to 100 and the values of other years are converted in the same ratio. This method is also used while preparing index numbers.
The Trend rations in the following example will be as follows:-

Years Sales Stock Profit before Tex

2009 1,881 709 321

2010 2,340 781 435

2011 2,655 816 458

2012 3,021 944 527

2013 3,768 1,154 672

Trend Ratios(Base year 2003= 100)

   Years    Sales       Stock   Profit before Tex

Amount (In Rs. Lakhs)      Trend % Amount (in Rs.Lakhs) Trend %
Amount(in Rs.Lakhs) Trend %

2009 1,881 100 709 100 321 100

2010 2,340 124 781 110 435 136

2011 2,655 141 816 115 458 143

2012 3,021 161 944 133 527 164

2013 3,768 200 1,154 162 672 209

Current year   × 100 Base year
Interpretation:-

1. The sale of the firm has continuously increased over a period of five years commencing from 2003. There has been a substantial increase in the amount of Sales in the year 2007 when it increases by 39%.
2. The Trend Stock also upwards. The increase in these items has been constant yet in 2007 the increase has been exceptionally high.
3. The Profits of the firm has increase at much higherrate in comparison to increase in Sales and Stock during the Period under Study.

The overall analysis of the financial items indicates that the firm is doing well and, its financial position is found to be good.