How do you prepare a financial trend analysis?
Blog //16-03-2022

How do you prepare a financial trend analysis?

by Amanda Grant, Chief Product Officer

Understanding how the past affects the future is a key skill for CFOs and business owners. Real-time automation of data is showing no signs of slowing down anytime soon, and finance teams who continue to use legacy accounting software and Excel to manually carry out financial trend analyses will find themselves unable to keep up with business demand. 

This is why it may be beneficial to explore new financial trend analysis methods and automation of processes via Cloud accounting software. Similar to predictive analytics or cash flow forecasting, trend analysis in the Cloud uses your historical financial data to help you understand and project future events.

What is financial trend analysis?

Financial trend analysis can provide valuable insights for CFOs stepping into the role of strategic leaders guiding their business through agile decision-making, accurate financial planning and analysis (FP&A) and forecasting by interpreting the right metrics.  

It encompasses financial data to assess a company’s performance and make recommendations about how it can improve going forward. A variety of data types available for financial trend analysis in the Cloud include traditional (profits or expenses) as well as alternative data (website traffic, customer complaints, POS transactions, etc.)

The process of trend analysis involves the collection of data from multiple periods (sometimes called ‘time series analysis’). The data is then analysed horizontally and plotted to determine trends. 

Data over a specific period can help you spot patterns and project future events. In other words, trend analysis is the idea that you can predict what mayhappen in the future based on what has already happened in the past.

How can businesses use financial trend data? 

Trend analysis is helpful for a business because keeping up with trends, rather than going against them, will help generate profits.

Think about cash flow management and using data management trends in financial services to make informed business decisions.

For example, you manage the finances for a business that makes spirits for bars and restaurants and a large bar chain wants to order 5,000 units. They inform you that they won't pay you until 90 days after you deliver the supply. The cash flow analysis of a recent financial trend indicates that you cannot afford to pay for the parts, employees, shipping, and all other expenses while you wait for the payment; so, you turn down the deal.

Imagine, given the same scenario, a business owner signing the deal without having seen the cash flow analysis. As soon as the ingredients, labour and shipping costs are paid, the order is sent to the bar chain, and the countdown to 90 days begins.

Unfortunately, by this time, the business has exhausted its funds. While the business is owed a lot of money, it lacks the savings to cover its day-to-day expenses, so it is forced to close before the payment arrives.

Financial trend analysis is usually applied in one of two ways in business.

1. Analysis of revenues and costs

Financial statement trend analysis can reveal trends within a company's accounts as well as inconsistencies. It could be the case that an expense was accidentally booked twice in each month, for example, if expenses spiked in one period and declined in the next. To catch mistakes before they are released more widely, trend analysis methods are often used to examine preliminary financial statements.

2. Investment analysis

Investing professionals use trend analysis methods to predict changes in stock prices. In addition to predicting the entire stock market, trend analysis is also useful in predicting whether a transition from a bull to a bear market (or vice versa) is about to take place. In the field of investment, trend analysis can be especially useful since investors are more likely to make a profit when they move with the trend instead of against it.

What are the benefits of trend analysis interpretation?

In addition to being useful for straightforward investment analysis, trend analysis also has other advantages.

Here are some of the key advantages of utilising financial trend analysis for your business:

  • Make forecasts using long-term trends, which can then be used to identify actionable patterns
  • Measure your organisation's long-term solvency by understanding its short-term liquidity position
  • Make better decisions regarding the future of your organisation by tracking the financial performance over a specific time period
  • Comparing the performance of your organisation with the standards of your industry as well as your competitor's
  • Make your company more profitable in the future by analysing its weaknesses and strengths, identifying gaps, and implementing changes
  • Identify and resolve any issues related to your organisation's financial health in good time

Steps to take when preparing for financial trend analysis

When preparing a financial trend analysis, it’s important to understand what type of trend analysis you are looking to conduct. The first step in financial trend analysis is deciding which segment, industry, or asset you want to use. Depending on your objective and the historical financial data available, you will also need to determine the period. There is no consensus on the actual amount of time for movement to be considered a "trend." As a result, this will depend on your objective and the data you have to hand. 

For the next steps, you must determine what type of trend analysis you are going to conduct, know what platform you are going to use, and ensure that the financial data you need is readily available. Many management tools can be used to perform financial trend analysis, ranging from Excel to Cloud accounting software, which is why you need to combine different analytical techniques since no one method will provide the most accurate conclusion. 

Remember that financial trend analysis is only as good as the information you have available. Even if you believe you have the most accurate information, statistical noise along with randomness will still cause your results to be distorted. Therefore, you should remain objective when reporting your results and keep an eye out for errors if manually carrying out the analysis.

Here is a comprehensive list of the ways in which financial trend analysis can be carried out in the Cloud and used to influence future business decisions:

Cash flow

This confirms a company's most lucrative revenue streams or identifies areas of deficiency, it provides timely updates of when and where money is moved within accounts, placing great emphasis on a company's ability to generate and manage their cash flow. 

A cash flow analysis may be based on operating cash flow (OCF), free cash flow (FCF), free cash flow to the firm (FCFF) and free cash flow to equity (FCFE). Starting with the statement of cash flows can be helpful, as it includes each of the three main sections: operational, investing, and financing activities.

Growth rates

The finance function plays a major role in reporting figures to the board by analysing historical growth rates and projecting future ones. Usually, it is these key areas that influence key financial decisions in the new year. A growth analysis can be performed using year-over-year growth (YoY), regression analysis, bottom-up analysis, which involves looking at individual revenue drivers, and top-down analysis, which looks at market share and market size.

Scenario planning

Modelling and valuing financial assets also involves performing sensitivity and scenario analyses as a means of measuring risk. Conducting scenarios and sensitivity analyses can help determine what the company's worst-case or best-case future might look like.

These financial planning and analysis (FP&A) scenarios are often prepared by the financial team to assist a company in preparing its budgets and forecasts. As changes in assumptions flow through the model, investment analysts use existing financial data to determine how sensitive the value of a company is to changes.

Leverage analysis

Leverage ratios are among the most used metrics for assessing a company's performance. To get a comprehensive picture of a company's capital structure, it's useful to compare a financial metric like debt to equity, the result of which is the debt/equity ratio. Debt/equity, Debt/EBITDA, EBIT/interest (interest coverage) and Dupont analysis are four of the most used ratios used in leverage analysis.

Vertical analysis

In this type of financial analysis, a variety of income statement components are divided by revenue and expressed as a percentage. A company's performance should be benchmarked against other companies in the same industry to determine how well it is performing. You can make use of this technique to assess how companies of different sizes compare when looking at their margins.

Horizontal analysis

Compares financial data from several years to determine growth rates that indicate whether a company is growing or declining, and to identify important trends. Using financial data collected over several years, a trend analysis can be conducted to compare the company's performance with other similar companies in the same industry.

Variance analysis

Actual results are compared to a budget or forecast. Internal planning and budgeting processes rely heavily on this type of analysis, especially for those in the finance department. Typically, this process involves examining whether a variance was favourable or unfavourable and then finding out the root cause of it. In other words, if your organisation had a budget of £7.5 million and revenue of £7.8 million, this would result in a £0.3 million favourable variance due to higher volumes than expected.

Profitability analysis

A way to assess how attractive a business's economics are through an income statement analysis. In addition to net profit margin and gross profit margin, EBITDA margin and EBIT margin are examples of profitability measures used in this form of analysis.

Liquidity analysis

The focus here is on the balance sheet, particularly the company's ability to meet short-term obligations, which are usually due in less than a year. In addition to current ratios, cash ratios, and net working capital, liquidity analysis may also include acid tests.

Efficiency Analysis

Efficiency ratios are a key component of any robust financial analysis since they measure how well a company uses its assets to generate revenue and cash flow. Asset turnover ratios, fixed asset turnover ratios, inventory turnover ratios, and cash conversion ratios are common efficiency ratios.

Valuation analysis

A major component of financial analysis is determining what a business is worth. The value of a business can be quickly and easily assessed via Cloud accounting software in many different ways, reducing the need to combine methods in Excel to arrive at a reasonable estimate. Measures used during valuation analysis include the cost approach, the cost to build/replace, intrinsic value, relative value (market approach), discounted cash flow analysis, comparable company analysis, and precedent transactions.

Rates of return

At the end of the day, investors, lenders, and the finance function are looking for the best risk-adjusted rate of return. Therefore, assessing the return on investment (ROI) is vital. Return on equity (ROE), return on assets (ROA), return on invested capital (ROIC), dividend yield, capital gain, accounting rate of return (ARR) and internal rate of return (IRR) are among the key metrics used to measure rates of return.

How Advanced Financials can improve your trend analysis processes

With Advanced Financials, your finance team can enjoy powerful analysis tools, automated real-time data collection, and a robust reporting engine with over 1,000 customisable reports at their fingertips.

Advanced Financials assists you in creating forecasts based on financial trends. By planning with current, projected, or past values, you are in control.

Predict market trends, sales forecasts, interest rates, and inventory requirements using accurate historical data and key performance indicators. Using trend-based planning, you can devise a strategy that uses measurable and verifiable data.

Take back the time your finance team spent manually creating financial data analysis through Excel. Advanced Financials automates analysis processes so more time is spent creating strategies around the results, rather than crunching the numbers.

We are here to help transform your finance function into an agile and strategic powerhouse, ready to lead your business into the successes of tomorrow. Get in touch with one of our experts today.

Advanced Financials Blog Business Intelligence Financial Management
Amanda Grant

Amanda Grant

PUBLISHED BY

Chief Product Officer

Amanda joined Advanced in 2018 and was promoted to CPO in 2019 following a successful stint as Product Strategy Director, being responsible for the correct investment decisions.

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