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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 trend and index analysis comes from the fact that indexes are a tool for conducting financial analysis or profitability analysis. Another use for ratios is to conduct benchmark analyses, where a company compares its financial data to that of another company. Analysis of trends and ratios typically occurs at the end of the month, year, or any time when a company decides that a review is necessary to evaluate financial information.
Trend and proportion analysis uses the same inputs: financial statements. These statements represent the accounting firm’s final output for a given period of time. Trend analysis typically measures the change in dollars between each line of a financial statement. Another column might list the percentage change between items as well. This provides a quick view of financial improvement in certain areas of a business.
The proportions take a little longer to compute. 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. Proportions can, however, establish a connection between trending and proportion analysis. For example, an accountant might keep a record for each index calculated over a period of time; this creates a bias towards financial comparison.
Another connection between trend and ratio analysis is its use to select 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 meet this need and match the stock price trend with 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.
Ratios also help companies compare themselves to companies with different operations. For example, a small business is simply unable to 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 operates compared to the large competitor. The small business can also turn this into a trend and ratio analysis report. This provides insights into how the small business can improve itself to be like a much larger operation.