Identifying trends across periods

Identifying trends across periods in financial statements, also known as horizontal analysis, involves comparing financial data over several accounting periods to observe changes and patterns. This analysis helps in understanding a company's performance and financial health over time.

Here's a general approach:

1. Select Financial Statements: Focus on the three primary financial statements:
   • Income Statement: To analyze trends in revenue, cost of goods sold, operating expenses, and net income.
   • Balance Sheet: To observe trends in assets (current and non-current), liabilities (current and non-current), and equity.
   • Cash Flow Statement: To understand trends in cash generated from operating, investing, and financing activities.
2. Choose Periods: Select at least two, but preferably three or more, consecutive periods (e.g., quarters or years) for comparison. The more periods you have, the clearer the trends will be.
3. Normalize Data (Common-Size Analysis - Optional but Recommended):
   • Income Statement: Express each line item as a percentage of total revenue for that period. This helps compare companies of different sizes or analyze internal efficiency trends regardless of revenue fluctuations.
   • Balance Sheet: Express each line item as a percentage of total assets for that period. This shows the composition of assets, liabilities, and equity over time.
4. Calculate Key Ratios and Metrics: Beyond just looking at absolute numbers or percentages, calculate relevant financial ratios for each period. This provides deeper insights into specific aspects of the business. Examples include:
   • Profitability Ratios: Gross Profit Margin, Operating Profit Margin, Net Profit Margin.
   • Liquidity Ratios: Current Ratio, Quick Ratio.
   • Solvency Ratios: Debt-to-Equity Ratio, Debt-to-Asset Ratio.
   • Efficiency Ratios: Inventory Turnover, Accounts Receivable Turnover, Asset Turnover.
   • Growth Rates: Year-over-year growth in revenue, net income, assets, etc.
5. Visualize the Data: Plotting the data (absolute numbers, percentages, or ratios) on line graphs or bar charts can make trends more apparent and easier to interpret.
6. Interpret the Trends:
   • Positive Trends: Consistent revenue growth, improving profit margins, increasing cash flow from operations, decreasing debt ratios (if appropriate), improving efficiency ratios.
   • Negative Trends: Declining revenues, shrinking profit margins, increasing operating expenses disproportionately, deteriorating liquidity, rising debt, declining efficiency.
   • Volatile Trends: Significant fluctuations might indicate instability or cyclical business operations.
   • Identify Drivers: Try to understand why certain trends are occurring. Is it due to market conditions, management decisions, economic factors, or industry-specific changes?

Example: If you observe a consistent increase in revenue over five years from the Income Statement, that's a positive trend. If, however, the Net Profit Margin is declining during the same period, it indicates that while sales are growing, the company is becoming less efficient at converting those sales into profit. This would prompt further investigation into rising costs or expenses.