What Is Trend Analysis? Understanding Its Role in Finance

Introduction to Trend Analysis

Financial trend analysis is a crucial component of strategic decision making in business. However, understanding trends is a crucial skill in any industry, including finance. According to Accounting Tools, trend analysis in accounting is a technique in which you analyze historical data to identify patterns and predict a company’s future financial position.¹

Financial statement trend analysis helps you assess your company’s place in the market and use it to guide strategic business decisions. For example, a trend analysis can show you if your company is losing business to competitors, in which case, you would reassess your product or your marketing efforts.

This post introduces you to financial trend analysis, including what it is, its role in the world of finance, and how you can conduct it.

Key Components of Trend Analysis

Trend analysis in accounting can be broken down into two main components.

The first component is identifying patterns in profits, expenses, and revenues. To do so, compare profit margins, expenses, and revenues over multiple periods. This will help you determine if your company is consistently generating profits and successfully managing expenses. For example, a consistent uptick in profits highlights a high demand for your product or service and a strong market position. On the other hand, rising expenses could signal that your company needs to consider cutting costs.

The second component of trend analysis in accounting is assessing historical data. You can do so by using accounting software to run financial statements for previous years or to access the records from your existing files. Reviewing past data helps you make more accurate forecasts. You learn to see patterns, including seasonal shifts and anomalies, that aren’t cause for alarm. For example, looking at financial statements from multiple previous years can show you that your profits consistently rise in the fourth quarter or that you typically experience a slow period over the summer.

Methods of Conducting Trend Analysis

You can conduct a trend analysis in multiple ways, including these typical methods.

Horizontal Analysis

Horizontal analysis compares historical financial data over multiple reporting periods.² To run this analysis, you might start with a base year and compare various metrics, such as cash flow or debt-to-income ratio. Many companies use this method to measure their year-over-year earnings to guide short-term decisions.

Vertical Analysis

A vertical analysis allows you to compare various items on a financial statement by calculating their value as a percentage of the total.³ You can use this method to compare different product lines, customer accounts, or departments in your company to see which produces the most revenue.

Vertical analysis also lets you compare your company to its competitors. If you’re operating a small business, converting line items to a percentage of the total gives you a more accurate picture of how your expenses and revenues align with your larger competitors. For example, your net profit may be $1 million, while your competitor is pulling in $10 million. However, if your net profit represents 60% of your total revenue and your competitor’s is 50%, your company is more profitable.

Comparative Analysis

Comparative analysis involves evaluating financial statements from the same period (such as a month or a quarter) side-by-side to identify patterns and trends.⁴ This trend analysis method can be used to compare internal metrics and guide operational decisions. It is also a good way to compare your company’s performance to that of your competitors in the industry.

Benefits of Trend Analysis

Performing a trend analysis of financial statements offers many benefits to your company:⁵

• Informed decision-making: Trend analysis helps you predict how your company will perform in the future, allowing you to make informed decisions about budgets, goals, and strategic planning
• Progress tracking: Comparing financial statements across years helps you measure progress toward financial goals
• Opportunities for growth: Detailed financial statement trend analysis reveals which portions of your business are driving profits and enhancing operational efficiency, which can help you uncover growth potential

As part of a company’s management team, you can present this information to leadership to guide decision-making. Trend analysis helps you see where your company is growing and where you are experiencing challenges. Management can use this data to mitigate risks and identify growth potential.

Applications in Finance

As a financial professional, you will periodically monitor profitability trends for your company.⁶ Comparing financial statements shows you if your profitability is increasing, decreasing, or remaining stable. This information guides everything from growth strategies to cost-cutting efforts. For instance, if your company demonstrates a steady increase in profitability, you may be more willing to take risks, such as launching new product lines or entering a new market.

When you notice a dip in profitability, your next step may be to examine how your company is managing costs. Comparing project budgets to actual costs will help you make more accurate projections in the future to keep you from going over budget.

Trends analysis also helps you stay on top of your company’s liquidity or solvency. It helps you understand your capability to meet financial obligations.

Limitations of Trend Analysis

Trend analysis does have its limitations.⁷ For one, using historical data to make predictions is less accurate in fast-paced, dynamic industries. For example, the renewable energy industry is continually experiencing shifts in technology and supply and demand, making historical data quickly obsolete.⁸

Market shifts across industries also impact trends analysis. You can’t always predict how a natural disaster, geopolitical conditions, or changing technology will impact your industry.

An accurate trend analysis in accounting also depends on accurate data. If you’re working with smaller datasets or inconsistent data, your predictions may be off.

Steps to Perform Trend Analysis

Start your trend analysis with an overarching goal.⁹ Knowing what you want to assess will guide your data collection and analysis efforts.

Next, collect your data. Make sure you use complete data sets in a similar format. For example, if you’re comparing financial statements from different companies, consider calculating line items as a percentage of the total to make an accurate comparison.

Then, choose your base year and benchmarks. You can calculate percentages over time for each of your key financial metrics. Note significant fluctuations, patterns, and trends related to your study objectives. Determine how these trends will impact your business and present your findings to interested parties.

Enhance Your Financial Statement Trend Analysis Skills 

Mastering financial statement trend analysis is an essential skill for success across all industries. Set yourself apart from the competition by strengthening your expertise with an Online Master’s in Finance and Analytics from Leavey School of Business at Santa Clara University. Our comprehensive curriculum will position you for success in today’s dynamic business landscape.

At Santa Clara University, you will learn from industry veterans with experience at some of the world’s most respected companies. You'll be prepared to excel in any professional setting. Throughout the program, you’ll also gain access to a network of faculty, alumni, and peers—an invaluable resource for advancing your career.

If you’re ready to get started, reach out to an admissions outreach advisor today.