Trend Analysis

Trend analysis calculates the percentage change for one account over a period of time of two years or more.

Percentage change
To calculate the percentage change between two periods: 1. Calculate the amount of the increase/(decrease) for the period by subtracting the earlier year from the later year. If the difference is negative, the change is a decrease and if the difference is positive, it is an increase. 2. Divide the change by the earlier year's balance. The result is the percentage change.

Calculation of Percentage Change 20X0 Increase/(Decrease) Percent Change 20X1 Cash $ 6,950 $ 6,330 19,330 103,000 0 (1,400) $ 620 (763) 26,000 10,000 9,530 9.8% (3.9%) 25.2% N/M N/M

Accounts Receivable, net 18,567 Sales Rent Expense Net Income (Loss) 129,000 10,000 8,130

Calculation notes: 1. 20X0 is the earlier year so the amount in the 20X0 column is subtracted from the amount in the 20X1 column. 2. The percent change is the increase or decrease divided by the earlier amount (20X0 in this example) times 100. Written as a formula, the percent change is:

3. If the earliest year is zero or negative, the percent calculated will not be meaningful. N/M is used in the above table for not meaningful. 4. Most percents are rounded to one decimal place unless more are meaningful. 5. A small absolute dollar item may have a large percentage change and be considered misleading.

Trend percentages
To calculate the change over a longer period of time for example, to develop a sales trendfollow the steps below: 1. Select the base year. 2. For each line item, divide the amount in each nonbase year by the amount in the base year and multiply by 100. 3. In the following example, 20W7 is the base year, so its percentages (see bottom half of the following table) are all 100.0. The percentages in the other years were calculated by dividing each amount in a particular year by the corresponding amount in the base year and multiply by 100.

Calculation of Trend Percentages 20X1 20X0 Historical Data Inventory

20W9

20W8

20W7

$ 12,309 $12,202 $12,102 $11,973 $11,743 78,938 30,347 97,000 59,740 64,203 27,670 95,000 48,100 65,239 28,259 87,000 47,200 68,450 26,737 81,000 45,500

Property & equipment 74,422 Current liabilities Sales Cost of goods sold 27,945 129,000 70,950

Operating expenses Net income (loss) Trend Percentages Inventory

42,600 8,130

38,055 (1,400)

32,990 7,869

29,690 5,093

27,050 3,812

104.8

103.9 115.3 113.5 119.8 131.3 140.7 (36.7)

103.1 93.8 103.5 117.3 105.7 122.0 206.4

102.0 95.3 105.7 107.4 103.7 109.8 133.6

100.0 100.0 100.0 100.0 100.0 100.0 100.0

Property & equipment 108.7 Current liabilities Sales Cost of goods sold Operating expenses Net income (loss) 104.5 159.3 155.9 157.5 213.3

Calculation notes: 1. The base year trend percentage is always 100.0%. A trend percentage of less than 100.0% means the balance has decreased below the base year level in that particular year. A trend percentage greater than 100.0% means the balance in that year has increased over the base year. A negative trend percentage represents a negative number. 2. If the base year is zero or negative, the trend percentage calculated will not be meaningful. In this example, the sales have increased 59.3% over the five -year period while the cost of goods sold has increased only 55.9% and the operating expenses have increased only 57.5%. The trends look different if evaluated after four years. At the end of 20X0, the sales had increased almost 20%, but the cost of goods sold had increased 31%, and the operating expenses had increased almost 41%. These 20X0 trend

percentages reflect an unfavorable impact on net income because costs increased at a faster rate than sales. The trend percentages for net income appear to be higher because the base year amount is much smaller than the other balances.

Comparative Financial Statement Analysis Comparative Financial Statement analysis provides information to assess the direction of change in the business. Financial statements are presented as on a particular date for a particular period. The financial statement Balance Sheet indicates the financial position as at the end of an accounting period and the financial statement Income Statement shows the operating and non-operating results for a period. But financial managers and top management are also interested in knowing whether the business is moving in a favorable or an unfavorable direction. For this purpose, figures of current year have to be compared with those of the previous years. In analyzing this way, comparative financial statements are prepared. Comparative Financial Statement Analysis is also called as Horizontal analysis. The Comparative Financial Statement provides information about two or more years' figures as well as any increase or decrease from the previous year's figure and it's percentage of increase or decrease. This kind of analysis helps in identifying the major improvements and weaknesses. For example, if net income of a particular year has decreased from its previous year, despite an increase in sales during the year, is a matter of serious concern. Comparative financial statement analysis in such situations helps to find out where costs have increased which has resulted in lower net income than the previous year. Example: Comparative Income Statement for the years ended 31st Dec 2008 & 31st Dec 2009 31st Dec 2008 Sales Less: Cost of goods sold Gross profit Less: Operating expenses General & administrative expenses Selling & distribution expenses Other operating expenses Operating profit Less: Interest expenses Net income before taxes Less: Taxes at 30% Net Income after taxes $7,000 $5,000 $2,000 $200 $400 $100 $1,300 $300 $1,000 $300 $700 31st Dec 2009 % of Increase/ increase / (Decrease) (decrease) $9,000 $2,000 28.57% $6,400 $1,400 28.00% $2,600 $600 30.00% $300 $500 $150 $1,650 $400 $1,250 $375 $875 $100 $100 $50 $350 $100 $250 $75 $175 50.00% 25.00% 50.00% 26.92% 33.33% 25.00% 25.00% 25.00%

Comparative Balance Sheets as on 31st Dec 2008 & 31st Dec 2009 31st Dec 2008 31st Dec 2009 % of Increase / increase / (Decrease) (decrease)

Current Assets: Cash Accounts Receivables Inventory Total Current Assets Fixed Assets: Buildings Furnitures & office equipments Total Fixed Assets Total Assets Liabilities: Current Liabilities: Accounts Payable Notes Payable Interest Payable Total Current Liabilities Shareholder's Equity: Common Stock Retained earnings Total Stockholder's equity Total Liabilities & Stockholder's equity

$500 $2,000 $1,500 $4,000 $3,000 $1,000 $4,000 $8,000

$600 $3,000 $2,500 $6,100 $4,000 $1,500 $5,500 $11,600

$100 $1,000 $1,000 $2,100 $1,000 $500 $1,500 $3,600

20.00% 50.00% 66.67% 52.50% 33.33% 50.00% 37.50% 45.00%

$1,000 $500 $100 $1,600 $5,000 $1,400 $6,400 $8,000

$1,200 $500 $120 $1,820 $7,500 $2,280 $9,780 $11,600

$200 $0 $20 $220 $2,500 $880 $3,380 $3,600

20.00% 0.00% 20.00% 13.75% 50.00% 62.86% 52.81% 45.00%

Common Size Financial Statement Analysis Common Size Statement involves representing the income statement figures as a percentage of sales and representing the balance sheet figures as a percentage of total assets. Financial statements represent absolute figures and a comparison of absolute figures can be misleading. For example, the cost of goods sold might have increased but as a percentage of sales it might have decreased. So, to have a perfect understanding about these increases and decreases, the figures reported are converted into percentages to some common base. In Income Statement, Sales figure is assumed to be 100% and all other figures are expressed as a percentage of sales. In Balance Sheet, the total of assets is taken as 100% and all other figures are expressed as a percentage of total assets. This type of Statement so prepared is called as the Common Size Statement and the analysis performed on the Common Size Statement is called as the Common Size Financial Statement Analysis or otherwise called as Vertical Analysis. Example: Common Size Income Statements for the years ended 31st Dec 2008 & 31st Dec 2009 2008 100.00% 71.43% 28.57% 2.86% 5.71% 2009 100.00% 71.11% 28.89% 3.33% 5.56%

Sales Less: Cost of goods sold Gross profit Less: Operating expenses General & administrative expenses Selling & distribution expenses

Other operating expenses Operating profit Less: Interest expenses Net income before taxes Less: Taxes at 30% Net Income after taxes

1.43% 18.57% 4.29% 14.29% 4.29% 10.00%

1.67% 18.33% 4.44% 13.89% 4.17% 9.72%

Common Size Balance Sheets as on 31st Dec 2008 & 31st Dec 2009 2008 Current Assets: Cash Accounts Receivables Inventory Total Current Assets Fixed Assets: Buildings Furnitures & office equipments Total Fixed Assets Total Assets Liabilities: Current Liabilities: Accounts Payable Notes Payable Interest Payable Total Current Liabilities Shareholder's Equity: Common Stock Retained earnings Total Stockholder's equity Total Liabilities & Stockholder's equity 6.25% 25.00% 18.75% 50.00% 37.50% 12.50% 50.00% 100.00% 2009 5.17% 25.86% 21.55% 52.59% 34.48% 12.93% 47.41% 100.00%

12.50% 6.25% 1.25% 20.00% 62.50% 17.50% 80.00% 100.00%

10.34% 4.31% 1.03% 15.69% 64.66% 19.66% 84.31% 100.00%

Trend Analysis Trend analysis involves the usage of past figures for comparison. Trend percentages are calculated for some important items like sales revenue, net income etc. Under this kind of analysis, information for a number of years is taken up and one year, which is usually the first year, is taken as the base year. Each item of the base year is taken as 100 and on that base, the percentage for other years are computed. This analysis will help in finding out the percentage of increase or decrease in each item with respect to the base year. Example: Calculate the trend percentages from the following figures of a company, assuming 2000 as the base year. Year 2000 Sales Net Income $100,000 $10,000

2001 2002 2003 2004 Solution: Year 2000 2001 2002 2003 2004 Workings:

$120,000 $160,000 $90,000 $150,000

$12,500 $20,000 $8,000 $18,000

Sales

Trend Trend Net Income Percentage Percentage $100,000 100 $10,000 100 $120,000 120 $12,500 125 $160,000 160 $20,000 200 $90,000 90 $8,000 80 $150,000 150 $18,000 180

If the trend percentage 100 represents $100,000 sales, then $120,000 worth of sales would have a trend percentage of => 100/$100,000 x $120,000 => 120. If the trend percentage 100 represents $10,000 net income, then $8,000 worth of net income (in year 2003) will have a trend percentage of => 100/$10,000 x $8,000 = 80 and so on.