Most financial statement readers look only at their monthly or annual reports, and most monthly or annual reports present their period data compared against the immediately prior period, or against the same period a year ago. The more enlightening reports compare results against a budget, which is a carefully thought-out benchmark in its own right. All good so far.
The Risk: In all these cases there is a flaw in the lone comparison that can prove dangerous over time. They overlook the fact that a small variance, a minor deterioration from the prior period, a tolerable budget variance, if repeated over a series of past and future periods, can become a major surprise when taken cumulatively. When the surprise is a pleasant one, everyone can laugh and say: “How weird we didn’t see that earlier.” However when the surprise is unpleasant, the tendency is to begin a frantic search for answers: “How did this happen?” “When did this happen?” “Why didn’t we know it was happening?” “Who’s responsible for this?”
One solution? A comparative report that shows a series of these measurements over consecutive periods – a trend report. Trends are most valuable because they give us clues to the future. In high school physics many of us learned the principles of centrifugal force: an object in motion tends to continue in motion in the same direction. Well, that may not be exactly what your teacher said, but it’s close enough for our purposes. Of course the object your teacher used to make her point didn’t have market forces, interest rates, recessions and human emotions to bump it around, or its path would have been a lot more erratic, perhaps even derailing it a time or two. So, too, the path of many of our economic indicators is often erratic, but that doesn’t change the validity of studying their trends to begin to predict where they might go in the future.
As we have observed, a strong sales effort that brings in good sales numbers tends to continue to do so, given no radical changes in its environment. A company whose costs are rising slowly and steadily because it doesn’t effectively control them will likely continue to see its cost rise until it takes some action to disrupt the trend. Human nature being what it is, costs are more likely to rise without controls than they are to fall of their own weight, so studying trends of costs is useful to enable management to identify those trends soon enough to keep the cumulative effect within acceptable limits.
My suggestion: Add two trend reports to your monthly financial statement package. The first trend report should be your income statement and the second your statement of cash flow. Each should present data for the past 8, 10 to 13 months, month by month, side by side, on one piece of paper. Check these out monthly and notice how much more you can see.
So, the value of trend reports – to enable you to predict the future performance of some key metric unless something changes. Sound too iffy for you? Compare it with the alternative: guessing.
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