Trend Analysis : an important tool of Analysis and interpretation of financial statements

TREND ANALYSIS
Trend 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 PERCENTAGE
Financial 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
(31st 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



31ST March


Sales (Rs.)

Increase/decrease in comparison to 2003
Increase/decrease In
% in comparison to 2003
Increase/decrease×100
Sales 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 RATIOS
Trend 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 higher  rate 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.

TYPES OF FINANCIAL STATEMENT ANALYSIS

TYPES OF FINANCIAL STATEMENT ANALYSIS
It is depend upon the user for which purpose they have used financial statement. User used financial statement according to their purpose from different angles. Generally various type of financial statement are classify into three (03) group depending upon
  •  The nature of the analyst and material used by him.
  • The objective of analysis.
  • The modus operandi of analysis.

According to the analyst and material used by him: - There are two types of analysis. 
  1. External analysis
  2. Internal analysis 
External analysis:-  External Analysis is comprises of those people who are not directly related or concern with the business. For examples include creditor, investor, government agency, etc. 
Internal analysis: - Internal Analysis is comprises of those people who are directly related or concern with the business and have the right to assess the book of accounts.  For examples Chairman Cum Managing, directors,  trustee, etc.

On the basis of objective of analysis:- There are two type of analysis  
  1. Long term analysis  
  2. Short term analysis 

Long term analysis:-  It is very necessary to made long term analysis so that we know whether the business will able to earn that much of amount which will be required to fulfill the rate of return to  the investors. Long term financial stability is determined by the long term analysis of the business.
Short run analysis:-  The short term financial stability, solvency and liquidity and profitability of concern are determined by the short term analysis

According to modus operandi of the analysis:-   There are two type of analysis 
  1. Horizontal  or dynamic analysis  
  2.  Vertical and static analysis

Horizontal or dynamic analysis:-  For comparing the financial data of the business year wise, it is necessary to made Horizontal or dynamic analysis. The figures in the Horizontal analysis are represented horizontally over a number of columns.
Vertical and static analysis:-  To review the analysis of financial statement for one particular year, Vertical and static analysis  to be made. The figure from financial statement of a year is compare with a base select from the same year’s statement in the vertical analysis.

QUALIFICATION OF THE ANALYST FOR ANALYZING FOR FINANCIAL STATEMENT
The analyst before analyze financial statement should be clear and sound knowledge of  
  1. Business practices and system,
  2. The main Purpose, Principle, characteristic and limitation of accounting systems of the business,  
  3. All the Accounting terminology,
  4. All the Tools and techniques of financial analysis.

He should know the following things about the firm to be more accurate
  1. Financial history of the concern
  2. Firm’s Depreciation and inventory policies,  
  3. Types and Locations of company,
  4.  Non financial matters.

PROCEDURE OF FINANCIAL SYSTEMS ANALYSIS
Following are procedure of Financial Systems Analysis: -
  • Compilation of information for purpose of analysis,
  • Systematic categorization of data,
  •  Interpretation or drawing of conclusion.

The following procedure is adopted by the analyst for the analysis and interpretation of financial statement of a firm:
  1. The analyst should have sound knowledge of principle and postulate of accounting. He should understand the plan and policies of the firm very clearly.
  2. The scope of analysis should be determine so that the area of work may be decided.
  3. The financial data should be re-arranging and re-organized given in financial statement.
  4. A relationship must be set up among the financial analysis with help of tools and technique of analysis such as ratios, trend, common-size, fund flow etc.
  5. The information must be interpreted in a very easy, simple, clear, and understandable way.
  6. The conclusion drawn from interpretation of financial statement should be in form of report before presenting to the management.

METHODS OF FINANCIAL STATEMENT ANALYSIS
1.     Trend analysis
·           Trend percentage
·           Trend ratio
·           Graphic and Diagrammatic presentation
2.     Comparative financial statement analysis.
3.     Common size statement.
4.     Average analysis
5.     Funds statement analysis.
6.     Ratio analysis.
7.     Component percentage analysis method.
8.     Break-even analysis method.

FINANCIAL STATEMENT ANALYSIS - DEFINITION, OBJECTIVE, IMPORTANCE, LIMITATIONS

Meaning
The analysis of financial statement is a process of evaluating the relationship between component parts of financial statement to obtain a better understanding of firm financial position.
Analysis is a process of critically examining the accounting information given in financial statements. For the purpose of analysis, individual items are studied; their interrelationship with other related figures is established.
Thus analysis of financial statement refer to treatment of information contain in financial statement in a way so as to afford a full diagnosis of the profitably and financial position of the firm concern.
Definitions
According to Myser Financial study analysis is largely a study of relationship among the various financial factor in the business as disclosed by the single set of statement and a study of trend of these factor shown in the financial statement”.

OBJECTIVE OF FINANCIAL STATEMENT ANALYSIS
Financial statement is helpful in assessing the financial position and profitability of the concern. Keeping in the view of accounting ratio the accountant should calculate the ratio in appropriate form as early as possible for presentation for management for managerial decisions.
Following are the main objectives of analysis of financial statements: -
1.    To evaluate the business in terms of profit in present and future.
2.    To evaluate the efficiency of various parts or department of the business.
3.    To evaluate the short term and long term solvency of business for distributing profit to the trade creditor and debenture holders.
4.    To evaluate the chances of growth of business in the future by preparing budgets and forecasting.
5.    To evaluate the operational efficiency of one firm with another firm by study the comparative statements.
6.    To evaluate the financial and economical stability of the business.
7.    To evaluate the actual meaning and consequence of financial data.
8.    To evaluate the long-term liquidity of the fund of the business.
  
IMPORTANCE OF ANALYSIS OF FINANCIAL STATEMENT
Financial statement is prepared at a certain point of time according to established convention. These statements are prepared to suit the requirement of the proprietor. For measuring the financial soundness, efficiency, profitability and future prospects of the concern, it is necessary to analyze the financial statement.  Following purposes are served by the Financial analysis: -
  1. Help in Evaluating the operational efficiency of the Concern:- It is necessary to analyze the financial statement for matching the total expenses incurred in manufacturing, Advertising, selling and distribution of the finished goods and total financial expanses of the current year comparing with the total expanses of the previous year and evaluate the managerial efficiency of concern.
  2. Help in Evaluating the short and long term financial position:- It is necessary to analyze the financial statement for comparing the current assets and current liabilities to evaluate the short term and long term financial soundness.
  3. Help in calculating the profitability:- It is necessary to analyze the financial statement to know the gross profit and net profit.
  4. Help in indicating the trend of achievements:-   Analysis of financial statement  helps in comparing  the Financial position of previous year and also compare various expenses, purchases and sales growth, gross and net profit.  Cost of goods sold, total value of assets and liabilities can be compare easily with the help of Analysis of financial statement.
  5. Forecasting, budgeting and deciding future line of action:-The potential growth of the business can be predicts by the analysis of financial statement which helps in deciding future line of action. Comparisons of actual performance with target show all the shortcomings.
LIMITATIONS OF FINANCIAL ANALYSIS

  1. It is Suffering from the limitations of financial statements
  2. There is Absence of standard universally accepted terminology in financial analysis
  3. price level changes is ignored in financial analysis
  4. quantity aspect is ignored in financial analysis
  5. Financial analysis provides misleading result in absence of absolute data

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