Trend Analysis

Trend analysis is an improvement over year-to-year analysis. When a comparison of financial statements covering more than three years in undertaken, the year-to-year analysis becomes too cumbersome. In trend analysis, changes are calculated for several successive years instead of for two or three years. Therefore, Trend analysis is a comparative analysis of a company's financial position over long period of time. Trend analysis is important because it may point to basic changes in the nature of a business and also helps in drawing meaningful conclusions regarding the operating performance over several years and financial position of the enterprise.  It is based on the idea that what has happened in the past gives an idea of what will happen in the future.

One of the main goals of trend analysis is to forecast future values of the series. It allows a researcher to look at a pattern of change over long time rather than at a single discrete point in time or over a short period so that better conclusions can be drawn.

The computation of a series of index numbers requires the choice of a base year that will have an index number of 100 for all items. The base period should be a normal year with regard to business conditions, since the base year used as a reference should be representative. Generally, the earliest year is selected as the base year. However, where the earliest year cannot fulfil the conditions of being a normal year then another year is chosen. All index numbers are computed with reference to the base year using this formula:

                   Index = 100 x Index Year Amount/Base Year Amount

In planning an index number trend comparison, it is not necessary to include in it all the items in the financial statements; only the most significant items may be included.  As in the case of year-to-year analysis, certain changes, and negative and positive amounts cannot be expressed by means of index numbers. Hence, this acts as a limitation of using trend analysis. The trend analysis using index number is also referred to as trend percentage.

The index number trend or trend percentage has been found to be well suited to comparison of changes in the working capital items over the years. The strength of trend analysis lies in the fact that it conveys to the analyst a better understanding of management's philosophy, policies, motivations, which are revealed through analysis over years. The more diverse the economic environments covering the periods compared, the better a picture of the ways in which the enterprise has weathered its adversities and taken advantage of its opportunities.

The first step in trend analysis is the preparation of a trend statement. For example, if we want to carryout trend analysis for five years, say, 2002 to 2006, of Infosys Technologies Limited we will take 2002 as base year. So the figures of each item of 2002 will act as 100. Then, we will convert financial statement items of the following years as a percentage of base-year value of 2002. Table 3 carries such percentages for two financial statement items and one can observe the trend of each item. For example, sales have increased to 347% in five years. And the trend of the sales is an increasing trend. Fixed assets also show an upward trend. However, growth in fixed assets is less than the growth in sales signifying better utilization of fixed assets.

Following is the Extract taken from the Annual Reports of Infosys:

                                                                                                 (Rs. in crore)

The above table is converted into percentage terms (i.e. trend analysis) by taking 2003 as base year. 

Trend Analysis in Percentage