A base year, or reference year, is a year that is used as a measure against which to compare data from a different year.
A base year, or reference year, is a year that is used as a measure against which to compare data from a different year. The data being compared can be prices, values, costs, or any other type of performance measure. Using this method allows the analyst to normalize the results over time, contextualizing the data in relation to the reference value. It controls for time-related factors, such as inflation, allowing disparate data to be compared on a common basis.
There are several contexts that use a base year to help compare information. Finance, real estate, and economics are just three examples of industries that use the concept extensively. In finance, a base year is used to measure the performance of stock indices over time. Financial analysts select a reference year and set the value of the index in that year equal to 100. Changes in the value of the index in subsequent years are expressed in terms of its percentage greater than or less than the standard mark.
In real estate, a base year is used as year one in commercial leases to determine the increases in common costs that the lessee must pay each year. Expenses in a subsequent year are expressed as a percentage increase over year one expenses. Instead of trying to share expenses with tenants, the landlord applies a comparison approach. If the common expenses increased by 20% in the first year, the tenant’s payment also increased by 20%.
The base year approach is widely used in economics to control for inflation and other market conditions that affect price and value over time. It helps to distinguish between real and nominal prices or values. Face values are expressed in terms of the cost of an item if money was used to purchase it in a given year. Actual value is controlled over time by expressing the price of the item in any year in terms of what the price would be in the base year.
This method is used to establish national standards to assess the performance of the economy, such as the consumer price index (CPI) in the United States. The gross domestic product (GDP) of a country is also calculated using a reference year to normalize prices over time. This form of data matching is so ubiquitous that it is used in matters large and small, from analyzing housing markets to determining eligibility for unemployment insurance.