How to use trend analysis in accounting?

October 24, 2015

Trend analysis may be a helpful tool to analyze various financial data.†In this article, we will review trend analysis and how it can be used in accounting and management.

1. Trend analysis

Trend analysis looks at financial (or non-financial) data over several periods to understand how the numbers changed over time.

Trend analysis is also called horizontal analysis because numbers are arranged horizontally.

It is possible to use trend analysis to look at dollar amounts, ratios or even non-financial information.† Data for at least two periods need to be compared to calculate changes (absolute and relative).† Looking at data for more than two periods will likely provide better insight, but is not always necessary.

Changes from one period to another are computed in absolute and relative terms.† For example, if we are looking at sales for two periods, then the dollar and percent changes can be determined.

2. Example of using trend analysis

Letís take a look at an example of trend analysis using financial data.† In our example, we will review sales of Company ABC over five years and calculate changes from one year to another:

 

Period 1

Period 2

Period 3

Period 4

Period 5

Sales

$100,000

$115,000

$110,000

$130,000

$140,000

Change ($)

n/a

$15,000

($5,000)

$20,000

$10,000

Change (%)

n/a

15%

(4%)

18%

8%

A few notes about the calculations in the table above:

  • There are no values for dollar and percent changes for the first period as there is no sales amount for the period prior to period 1.
  • The dollar change is calculated as the difference in sales between two periods.† For example, the change for period 2 is calculated as $115,000 - $100,000 = $15,000.
  • The percent change is calculated as the difference between two periods divided by the earlier (base) period.† For example, the change for period 2 is calculated as $15,000 ų $100,000.

As we look at the trend analysis, we can see that the company accomplished growth in sales except for the third period which shows a decrease in sales.† This is something that may require further investigation.† Was there economic recession during the third period?† Did the company have to halt its operations due to unforeseen circumstances (e.g., fire at the plant)? There may be a number of reasons for the decrease in sales during this period.

It is helpful to look at the sales trend; however, does it provide sufficient insight as to whether the companyís financial performance during those periods was great?† Probably not because we canít see how the companyís other financial data and indicators changed from one period to another.

An additional trend to be analyzed may be the cost of sales (cost of goods sold).† Letís add that to the table:

 

Period 1

Period 2

Period 3

Period 4

Period 5

Sales

$100,000

$115,000

$110,000

$130,000

$140,000

Change ($)

n/a

$15,000

($5,000)

$20,000

$10,000

Change (%)

n/a

15%

(4%)

18%

8%

           

Cost of sales

$80,000

$90,000

$85,000

$100,000

$120,000

Change ($)

 

$10,000

($5,000)

$15,000

$20,000

Change (%)

 

13%

-6%

18%

20%

The table shows that the cost of sales changed in a reasonable proportion to the changes in sales except for period 5.† In period 5, sales increased by 8% while the cost of sales increased by 20%.† This is a significant difference.† Typically, sales and cost of sales change in the same proportion.† In the case of period 5, something must have happened resulting in a larger increase in the cost of sales than the increase in sales.† Did the company lose one of its major supplies and was required to switch to another supplier with higher inventory costs?† Was there an accounting error?† These kinds of questions can help understand how the company has been performing and where it may be heading in the future.

Trend analysis can be used in various situations.† Investors can use it to decide if they want to invest in a company.† Company management may analyze trends to assess the companyís performance and make management decisions.† Auditors can use trend analysis as part of their audit procedures.

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