Trend percentages are similar to horizontal analysis except that comparisons are made to a selected base year or period. Trend percentages are useful for comparing financial statements over several years because they disclose changes and trends occurring through time.
Trend percentages, also referred to as index numbers, help you to compare financial information over time to a base year or period. You can calculate trend percentages by:
- Selecting a base year or period.
- Assigning a weight of 100% to the amounts appearing on the base-year financial statements.
- Expressing the corresponding amounts on the other years’ financial statements as a percentage of base-year or period amounts. Compute the percentages by Analysis year amount / base year amount and then multiplying the result by 100 to get a percentage.
The following information for Synotech illustrates the calculation of trend percentages:
|Cost of goods sold||4,696.00||5,223.70||5,341.30|
|Income before income taxes||$1,055.90||$436.20||$1,145.50|
We will calculate the trend percentages using 2ox3 as the base year and everything in 20Y3 will be 100%. For Net Sales in 20×4, take $10,029.80 from 20Y4 / 9,105.50 from base year 20Y3 and multiply by 100 to get 119.6%. For Net Sales in 20Y5, take $10,498.80 from 20Y5 / 9,105.50 from base year 20Y3 and multiply by 100 to get 115.3%. The same process continues for each account using the amount for each account in the base year 20Y3. The trend analysis would look like this (calculations added beside each column):
|Cost of goods sold||100||111.2||(5,223.70||113.7||(5,341.30|
|Income before income taxes||100||41.3||($436.20||108.5||($1,145.50|
These trend percentages indicate the changes taking place in the organization and highlight the direction of these changes. For instance, the percentage of sales is increasing each year compared to the base year. Cost of goods sold increased at a lower rate than net sales in 20Y3 and 20Y5, causing gross profit to increase at a higher rate than net sales. Operating expenses in 20Y4 increased due to the provision for restructured operations, causing a significant decrease in income before income taxes. Percentages provide clues to an analyst about which items need further investigation or analysis. In reviewing trend percentages, a financial statement user should pay close attention to the trends in related items, such as the cost of goods sold in relation to sales. Trend analysis that shows a constantly declining gross margin (profit) rate may be a signal that future net income will decrease.
As useful as trend percentages are, they have one drawback. Expressing changes as percentages is usually straightforward as long as the amount in the base year or period is positive—that is, not zero or negative. Analysts cannot express a $30,000 increase in notes receivable as a percentage if the increase is from zero last year to $30,000 this year (remember, you cannot divide by zero). Nor can they express an increase from a loss last year of – $10,000 to income this year of $20,000 in a realistic percentage term.
Proper analysis does not stop with the calculation of increases and decreases in amounts or percentages over several years. Such changes generally indicate areas worthy of further investigation and are merely clues that may lead to significant findings. Accurate predictions depend on many factors, including economic and political conditions; management’s plans regarding new products, plant expansion, and promotional outlays; and the expected activities of competitors. Considering these factors along with horizontal analysis, vertical analysis, and trend analysis should provide a reasonable basis for predicting future performance.