What is trend analysis?
Trend Analysis is a technique used to project the current and future movement of events by using a time series data analysis. It involves the comparison of data over a specific period of time to spot a pattern or trend. Trend analysis methods can be used to forecast how the business will perform, however, it is also important to be aware of the method’s limitations. When business variables including sales, revenue, or customer complaints change over time, the patterns that make up the trends can be observed. This allows businesses to project historical data to obtain future values.
Benefits of using trend analysis
Facilitates comparison
Using market trend analysis, analysts can make a well-charted comparison between two or more companies for a given period of time. It also acts a great tool to compare the company’s performance with the industry average. Trend analysis methods make it simpler to ascertain the strengths and weaknesses of a particular firm with respect to other related firms operating in the industry. This can help companies to quickly identify the gaps and implement the necessary changes.
Measuring financial performance
Trend analysis can be used to undertake a comparative study to measure the financial performances of the firm over a period of time. Through this the management to make decisions for the future and alter their processes or actions accordingly. Trend analysis (in terms of percentage) is found to be more effective when compared to the absolutes figures/data, facilitating top management in better decision-making.
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Understanding liquidity positions
Trend analysis methods help analysts and the management to understand the short-term liquidity position of the company. It is also an ideal tool to measure the long-term solvency position of a firm over the years by using related financial trend ratios.
Measuring profitability position
Market trend analysis help companies measure their profitability positions over a given period of time. This can be done with the help of some common related financial trend ratios including operating ratio, net profit ratio, and gross profit ratio.
Limitations of trend analysis
Selection of base year
Selecting a base year often proves to be a difficult task in market trend analysis. In most cases, a normal year is taken as the base year. But it is very critical and equally and hard to select the base year for the purpose of ascertaining the trend. If the ideal base year is not selected, chances are that the comparison or trend analyses will not be able to give accurate predictions.
Not useful in inflationary situations
The use of trend analysis to compare the data at the time of price-level change or inflation is useless. Data taken in such situations for the purpose of comparison will give adverse and misleading results. For instance, while analyzing the data for a period that has experienced inflationary trends, the data might show a growth in the company’s revenue, but this does not indicate better performance. The figures would be highly merely due to the inflation in prices.
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