Question

How does trend analysis supplement the basic financial ratio calculations and their interpretation?

Answer 1

Financial ratio calculation for a single year gives idea about profitability, liquidity, solvency and efficiency of operations of the business .

But stand alone ratios for just one year do not give idea about whether the ratios are improving or deteriorating.

In absence of any benchmark, the information derived from financial ratio calculations for one period has very limited use in taking appropriate action.

In trend analysis , the financial ratios are prepared for last few years and the current years’ ratios are compared with the earlier years to ascertain the trend and find out the areas which require attention.

In future projections also, financial ratios are calculated baced on next few years’ projected financial statements and a trend of the ratios are arrived at..