When determining whether a company is a suitable investment, people should review the businesses financial statements. The Income Statement, Balance Sheet and Cash Flow Statement show the financial operations of the business.
For public companies, financial statements are issued every three months, and are easily available on sites such as Yahoo! Finance. For private companies, those seeking to invest should get a copy of the financial statements for multiple years.
Trending Analysis of Financial Statements
For comparative purposes, statements usually show two or more years side by side. This allows the investor to easily compare trends. If the statement only has one year, it is still advisable to obtain prior year statements, if available.
New companies will only have current statements, and some companies may have substantially changed from one year to the next. If possible, those presenting the financial statements will try to present comparable financials over time.
Consistency in Accounting
One of the main tenets in accounting is consistency. Statements should present items in the same manner as prior years. For instance, companies should use the same method of depreciating capital assets each year. If there is a change in a method that materially effects the financially statements, it must be disclosed.
If the change would seriously distort the fair presentation of the statements and the understanding by the reader, the prior year statements should be restated using the current year method.
An Example of Trending Analysis
The office supply company, XYZ has been in business a number of years and statements are available to analyze trends on Yahoo Finance.
From the income statement:
- 2013 $ 50,000,000
- 2014 $ 55,000,000
- 2015 $ 45,000,000
- 2013 $ 48,000,000
- 2014 $ 52,000,000
- 2015 $ 47,000,000
- 2013 $ 2,000,000
- 2014 $ 3,000,000
- 2015 $ (2,000,000)
Both revenues and expenses increase from 2013 to 2014, and then both decreased in 2015. The decline in 2015 revenue can likely be attributed to the general economy, where many companies saw declines. The results show that management at XYZ did make efforts to reduce costs in 2015.
The bottom line, that is, profit or loss, the difference between revenue and expenses, makes clear that revenue decreased more than expenses, which threw the company into a loss.
Analyzing the Financial Trend
Accounting looks at history; what happened in the past. It is not guaranteed that past trends will continue into the future. Economic conditions change, and management also reviews trends and usually takes action to reverse bad results.
Investors should review statements and financial ratios for trends, but be aware that trends can change quickly, just as the upward change at XYZ in 2014 was immediately reversed in 2015.