The historical analysis of performance in comparison with the organizations current and past performance
In financial analysis, the direction of changes over a period of years is of crucial importance. Time series on trend analysis of ratios indicate the direction of this change.
The measure of performance over a period of time help to determine whether a firm is progressing as expected. Trend analysis is carried out to determine the following:
• How the firm has been performing over time.
• The accuracy of past predictions by looking at estimates against actual performance
• The data obtained can be used for financial forecasting
Trend analysis is particularly applicable to the items of the profit and loss account. The trends of sales and net income may be studied in the light of two factors: the rate of fixed expansion in the growth of the business and the general price level.
A number of firms may show a persistent growth over a period of years but get a true trend of growth, the sales figures must be adjusted by a suitable index of general prices i.e. deflated for rising price levels. A graph of the resulting figures will give the true trend of growth devoid of price change. If the general price level is not considered in the trend analysis, it may mislead management. In carrying out a trend analysis, three issues should be considered.
1. Describe the trend e.g. is the liquidity position improving or declining?
2. Give possible causes on the trend.
3. Give the implication of the trend.