Trend analysis and ratio analysis are the tools we use for financial analysis. The former is used for interpreting techniques used in the establishment of patterns in the financial statement. The latter, on the other hand, offers insight into the elements of financial statements and how these elements relate to each other. We use the financial analysis to assist us in carrying out analyze of a given firm.
Examples of the Tools Used in Financial Analysis
They are mainly three such examples here and include the preparation of comparative financial statements, common-size statements, and trends or percentages.
- The comparative income statement shows the relationship between sales and cost of goods sold.
- For the common size statements, each statement reduced to a total of 100% before being expressed as a percentage of the whole.
- Finally, on-trend percentages, we compare past data covering a given period and one base year.
Types of Trend Analysis
There are two main types, i, e the vertical and horizontal analysis.
- The horizontal analysis is used for showing trends of financial statements over several years. This analysis builds projection models for forecasting future financial performance. Secondly, you would need this analysis is used for identifying problem areas by looking for any abnormal changes in financial statements.
- On the other hand, the vertical analysis is used for comparing financial statements of various firms with those of others spread over some specific time frames. In the vertical, we take total assets in the balance sheet and total sales in the income statement as the base number (100%)
Size can be a problem in the vertical analysis and therefore, must be removed in the ratio analysis. The idea is to use common –size situation in the financial statements. The reason for the choice of the common size of the common –size financial statements is that it is used. It is restated as a percentage.