Overview of Trend Analysis – Definition, Methods and Limitations

Overview of Trend Analysis

In overview of trend analysis, we will be discussing Trend Analysis definition, methods, advantages and limitations.

Trend Analysis Definition

It refers to the calculation of percentages relationship that each statement bears to the same item in the base year.

Trend percentages analysis moves in one direction-either upward or downward progression or regression. The base year may be one of the period used in analysis. However in most cases, the earliest period is taken as base year.

There are plenty of ways to represent trend percentage such as in vertical or horizontal manner.  They can be plotted on a chart or on a graph by slotting curves. They are sometimes calculated using the trend “X” as index.

Methods of Calculation of Trend Percentage

1. The Statement of any of the years is taken as the base.
2. Every item in the base year statement is taken as 100
3. Trend ratios are computed by dividing each figure in the other years statement with the corresponding item in the base year statement and the result is expressed as percentages.

Advantages of Trend Analysis

1. Trend percentages indicate the increase in an accounted item along with the magnitude of change in percentage which is more effective then absolute data.
2. The trend percentage facilitates an efficient comparative study of the financial performance of business enterprises over a period of time.

Limitations of Trend Analysis

1. Any one trend by itself is not very analytical and informative.
2. If interpretation has to be done on percentages and ratio in isolation and not along with the absolute data from which the percentages have been derived, the interferences tend to be absurd and baseless.
3. Comparability of trend percentages is unfavorable affected when accounts have not been drawn on a consistent basis year after year and when the price level is not constant.
4. During the inflationary periods the data over a period of time becomes incomparable, unless the absolute rupee data is adjusted.
5. There is always the danger of selecting the base year which may not be representative, normal and typical. f. Trend percentages calculated for items having no logical relationship with one another tend to be meaningless and unscientific.
6. Though the trend percentages provide significant information, undue importance and emphasis should not be laid down on the percentages when there is a small number in the base year. In such cases, even a slight variation will be magnified by the percentage
   change.

Precautions To Be Taken Before Preparing Trend Statements

1. There should be consistency in the principles and practices followed by the organization through out the period for which analysis is made.
2. The base year should be normal i.e. representative of the items shown in the statement.
3. Trend percentages should be calculated only for the items which are having logical relationship with each other.
4. Trend percentages should be studied after considering the absolute figures on which they are based.
5. Figures of the current year should be adjusted in the light of price level changes as compared to the base year before calculating trend percentages.

Illustration 1: Calculate the trend percentages from the following data relating to asset side of the Balance sheet of X Ltd. taking year ending 31st March 2006 as the base year:

Solution: