In this financial era, people want to invest by gaining an outlook about how a company is
going to perform in the future. For this, they have to gain an understanding of the past to
predict future. Here comes the use of trend analysis. Trend analysis helps to recognize a
pattern and on its basis, predict the future.
In the field of finance, trend analysis means evaluating company’s key financial indicators
to determine its future value. These indicators might include revenue, profit, cash flow,
debt, or stock prices. The goal is to forecast future performance and make informed
judgement on this basis.
Importance of trend analysis in finance
Forecasting future performance: By performing trend analysis of financial
statements,a company can predict future budget. This is important for cost
management of a company.
Evaluating investment: By doing the stock market trend analysis, trend
analysis of particular industry in which a company is doing business, a company
can evaluate its investment. If the trend is upward, an investment has chances of
growing and if the trend is downward, an investment has chances of not growing.
Assessing financial health: Trend analysis helps to access financial health of
an organization. For example, by comparing the trend of P/E ratio over time, one
can know how well the company will perform in the future. Similarly, the EPS ratio
comparison shows if the earning per share of a company is growing over time.
Strategic planning: Trend analysis helps in strategic planning. It shows that budget
can be directed in other sector because the cost in one sector is unlikely to exceed
a minimum threshold. This helps companies to manage their cost and the likely of their
survival will increase in the market.
Types of trends in Financial Analysis (Trend Analysis Of Financial Statements)
Revenue trends: This trend analyzes if the revenue is increasing over time or
decreasing over time. If the company has consistent revenue growth over time, then
it is a signal that a company has gained goodwill in a market.
Expense Trends: This trend measures the direction that expenses of a company are
following relative to revenue. I.e they are uptrend or downtrend. If the expenses are
uptrend continuously, it shows that a company is unable to manage its costs.
Profitability Trends: This trend measures the direction that the profit of a company
is taking. I.e whether the gross profit margin, operating margin or net profit margin are
increasing with time or they are decreasing with time. If they are increasing over time,
then it indicates that the company is in good position in the market. But if it is
decreasing over time, then it can be the signal that the company is losing market.
Liquidity and solvency trends: This metric calculates the trend in ratios like current
ratio, debt-to-equity ratio and interest coverage ratio. If these ratios maintain a standard
value, then it indicates that the liquidity and solvency position of a company is good. I.e
they are able to pay their liabilities.
Stock Market Trends: Stock market trend is the trend shown by stock market.
Depending upon information, stock market shows upward or downward or
horizontal trend.
Methods of conducting trend analysis in Finance
Horizontal analysis: This analysis method calculates the movement of financial
statement items over different time periods. For example: If a company calculates
the increase in revenue from year 2017 to 2025, then it is an example of horizontal
analysis.
Vertical analysis: It is an analysis method in which each item of financial statements
are represented as a percentage of base figure. For example: showing line items like
cost of goods sold as a percentage of total revenue. If it is done for one company, it
shows the performance of a single company. But If it is done for multiple companies,
it helps in comparing the financial statements of multiple companies because it
standardizes financial datas. Its another name is common size analysis.
Ratio analysis: Since ratios are good indicators of financial health of an organization,
comparing the change in ratios over time is crucial to understand an organization. We
can also compare ratios of different companies to gain a better understanding of them.
Moving average: This technique smoothes out the shorter term fluctuations and show
longer term trends. Thus they help in trend analysis. To perform this analysis, cluster of
samples are made and average is calculated. Now the trend in this average is calculated.
This calculation is considered more effective because asexplained earlier, it smoothes out
shorter term fluctuations.
Conclusion: In this modern era, trend analysis has become part of financial organizations.
This is because these organizations need information about their performance with time.
Also they need prior information about how well they will do. Thus, it is crucial that we
have knowledge about trend analysis.
