businessman with a folder
Financial analysis often looks at past information and compares it to current data. This process, called trend analysis, helps the company understand what it does well and what it doesn’t. The connection between indices and trend analysis comes from the fact that indices are a tool for performing financial analysis or profitability analysis. Another use of ratios is to perform benchmark analysis, in which a company compares its financial data to that of another company. Trend and ratio analysis typically occurs at the end of the month, year, or any time a company decides a review is necessary to evaluate financial information.
Trend and ratio analysis uses the same inputs: financial statements. These statements represent the final output of the accounting firm for a given period of time. Trend analysis typically measures the change in dollars between each line on a financial statement. Another column could also list the percentage change between items. This provides a quick view of financial improvement in certain areas of a business.
The proportions take a little longer to calculate. Many financial statements used in trend analysis do not have automatic ratios calculated by accounting software. Accountants, therefore, need to use a series of mathematical formulas to create indicators or indicative percentages of indices. However, ratios can make a connection between trend analysis and ratio analysis. For example, an accountant might keep track of each calculated index over a period of time; this creates a bias towards financial comparison.
Another connection between trend and ratio analysis is their use in selecting stocks. Many investors look for trends in stock price charts as this can provide an indication of when to buy a stock. Fundamental analysis then requires an analysis of the company behind the stock. Indices can help fill this need and match the stock price trend to a financially strong company. One way to complete this analysis is to calculate a small set of ratios and determine how well the company performs in terms of profitability, asset turnover, and financial leverage.
The indices also help companies compare themselves to companies with different operations. For example, a small business simply cannot have the sales or other operational resources of a much larger organization. The ratios, however, eliminate these differences and provide indicators that show how the small company performs compared to the large competitor. The small business can also turn this into a trend and ratio analysis report. This provides insight into how the small business can improve to be like a much larger operation.