Financial Analysis · Lesson 7
Trend Analysis
Big Idea
One year of statements is a photograph; several years are a film. Trends show whether the company is strengthening, weakening, or wobbling sideways — and they are your best defence against a single flattering year.
Two simple techniques do most of the work: horizontal analysis (compare each year to the prior year) and vertical analysis (express every line as a percentage of revenue).
Horizontal Analysis: Year Over Year
| Year | Revenue | Change |
|---|---|---|
| Year 1 | $1,000,000 | — |
| Year 2 | $1,100,000 | +10.0% |
| Year 3 | $1,200,000 | +9.1% |
| Forecast Year 4 | $1,800,000 | +50.0% |
Three years of steady ~10% growth, then a forecast of +50%. A large projected jump is not automatically wrong — but it demands a clear explanation. Signed contracts? New capacity coming online? A new market actually entered? Or just a spreadsheet cell someone typed?
The question to hold onto: what changed enough to justify the jump?
Vertical Analysis: Everything as a % of Revenue
| Item | Year 1 | Year 2 | Year 3 |
|---|---|---|---|
| Revenue | 100% | 100% | 100% |
| Cost of goods sold | 60% | 62% | 65% |
| Gross profit | 40% | 38% | 35% |
| Operating expenses | 30% | 31% | 33% |
| Net income | 10% | 7% | 2% |
Revenue grew every one of these years — and profitability collapsed from 10% of sales to 2%. Dollar figures hid it; percentages expose it. Candidate causes: rising input costs, pricing pressure, discounting to buy growth, or operational inefficiency creeping in.
Revenue may be growing while profitability is deteriorating. Vertical analysis is how you notice.
Historical vs Projected: The Forecast Should Rhyme with the Evidence
| Measure | Historical average | Projected average |
|---|---|---|
| Revenue growth | 5% | 35% |
| Gross margin | 32% | 45% |
| Net margin | 4% | 18% |
| Operating cash flow | $50,000 | $400,000 |
Every projected line is a multiple of what the company has ever achieved. For each gap, ask: why is growth suddenly faster? Why do margins improve? Are working capital needs and debt repayments even in the forecast?
Forecasts are not facts. They are assumptions translated into dollars — Lesson 9 is entirely about stress-testing them.
Interactive Checks
Check 1 of 3
Revenue was $1,200,000 last year and $1,380,000 this year.
What is the horizontal (year-over-year) growth rate?
Check 2 of 3
Over three years, a company's revenue grew every year, while net income fell from 10% of revenue to 2%.
Which technique reveals this pattern, and what does it say?
Check 3 of 3
A company that has grown ~10% a year for three years forecasts +50% next year.
What is the right investor response?
Common Beginner Mistakes
- ❌ Judging from one year. A single period can flatter or slander; trends tell the truth.
- ❌ Watching only dollar amounts. Rising revenue with shrinking margins is deterioration in a growth costume.
- ❌ Taking hockey-stick forecasts at face value. If the future looks nothing like the past, someone owes you an explanation.
- ❌ Forgetting the outside world. A 5% decline in a market that fell 20% is strength, not weakness — context matters.
Key Takeaways
- Horizontal: compare each year to the last — the direction of travel
- Vertical: every line as % of revenue — the shape of the business
- Growing sales can hide collapsing profitability
- Forecasts should rhyme with the evidence of history
- Big jumps demand proportionally big support
Next Lesson
Ratio Analysis for Investors — a focused toolkit: liquidity, profitability, leverage, efficiency, and valuation, with a worked example for each.