Trend Analysis: Procedure (With

Calculations) | Method of
Financial Analysis
Trend analysis for analyzing financial statement and its
procedure.
The financial statements may be analyzed by computing trends of
series of information. This method determines the direction upwards
or downwards and involves the computation of the percentage
relationship that each statement item bears to the same item in base
year.

The information for a number of years is taken up and one year,

generally the first year, is taken as a base year. The figures of the base
year are taken as 100 and trend ratios for other years are calculated on
the basis of base year. The analyst is able to see the trend of figures,
whether upward or downward. For example, if sales figures for the
year 2006 to 2011 are to be studied, then sales of 2006 will be taken as
100 and the percentage of sales for all other years will be calculated in
relation to the base year, i.e., 2006

Suppose the following trends are determined.

The trends of sales show that sales have been more in all the years
since 2006. The sales have shown an upward trend except in 2008
when sales were less than the previous year i.e., 2004. A minute study
of trends shows that rate of increase in sales is less in the years 2007
and 2008.

The increase in sales is 15% in 2006 as compared to 2007 and increase

is 10% in 2007 as compared to 2006 and 5% in 2008 as compared to
2007. Though the sales are more as compared to the base year but still
the rate of increase has not been constant and requires a study by
comparing these trends to other items like cost of production, etc.

Procedure for Calculating Trends:

(1) One year is taken as a base year. Generally, the first or the last is
taken as base year.

(2) The figures of base year are taken as 100.

(3) Trend percentages are calculated in relation to base year. If a figure

in other year is less than the figure in base year the trend percentage
will be less than 100 and it will be more than 100 if figure is more than
base year figure. Each year’s figure is divided by the base year’s figure.

The interpretation of trend analysis involves a cautious study. The

mere increase or decrease in trend percentage may give misleading
results if studied in isolation. An increase of 20% in current assets may
be treated favorable. If this increase in current assets is accompanied
by an equivalent increase in current liabilities, then this increase will
be unsatisfactory. The increase in sales may not increase profits if the
cost of production has also gone up.

The base period should be carefully selected. The base period should
be a normal period. The price level changes in subsequent years may
reduce the utility of trend ratios. If the figure of the base period is very
small, then the ratios calculated on this basis may not give a true idea
about the financial data. The accounting procedures and conventions
used for collecting data and preparation of financial statements should
be similar otherwise the figures will not be comparable.

Illustration:
Calculate the trend percentages from the following figures of
X Ltd. taking 2007 as the base and interpret them:

ADVERTISEMENTS:
Interpretation:
(1) The sales have continuously increased in all the years up to 2011.
The percentage in 2011 is 200 as compared to 100 in 2007. The
increase in sales is quite satisfactory.

(2) The figures of stock have also increased from 2007 to 2011. The
increase in stocks is more in 2003 and 2007 as compared to earlier
years.

(3) Profit before tax has substantially increased. In five years period it
has more than doubled. The comparative increase in profits is much
higher in 2010and 2011 as compared to 2009.
Business finance is a function used to manage a company’s physical and financial resources.
Medium- and large-sized companies may employ an accountant or business analysts to handle this
responsibility. Small-business owners usually conduct financial analysis themselves, since the new
business venture may not be able to pay for an employee dedicated to these tasks. However, small
businesses can hire professional help to do these functions on a limited basis. Investment Decisions

Small-business organizations often use business finance formulas to make investment decisions. Companies
invest capital earned from business operations into investment instruments to earn a passive income stream
through dividends, or to earn a capital gain when selling the investment at a future date. Stocks, bonds and
similar instruments are common business investments. Business finance formulas such as return on investment
or the capital asset pricing model are finance tools used to measure the expected rate of return from the
investments.

Financing Analysis

Many companies use business finance principles to analyze financing options for major purchases or new
growth opportunities. Traditional bank loans and equity investments from private investors are the two most
common financing methods in business. Business finance formulas such as weighted average cost of capital or
capital structure analysis can be used to determine how much debt or equity to use when obtaining external
financing. Financing principles usually measure debt options based on interest rates, loan terms and loan
repayment methods.
Balance Sheet Evaluation

Business finance principles can be applied to a company’s balance sheet using financial ratios. These ratios
provide businesses with financial indicators that tell owners how well the company is utilizing its economic
resources. Ratios usually calculate how much cash a company has to pay off short-term debts, the long-term
financial stability of the business, the amount of fixed costs in operations and other financial information.
These ratios can provide companies with a benchmark to compare against industry standards.

Cash Management

Cash management is another important business finance principle. Businesses can use cash management
formulas to assess how much cash the company is generating from its operations. One finance analysis
procedure is to review the financial information listed on the company’s statement of cash flows. This
statement lists all cash inflows and outflows from operating, investing and financing operations. Companies
may also use the net present value formula to assess how much future cash inflows the company is expecting,
compared with current cash outflows. This formula allows companies to compare future inflows against
current outflows to see if business operations will continue to provide sufficient cash returns.

Financial statement analysis is useful in anticipation of future conditions and planning for actions that will
improve the firm's future performance. Financial ratios are designed to help you evaluate a financial statement.
Users of financial information such as creditors, investors, management and financial analyst use ratio analysis
for different purposes, such as analyzing liquidity and profitability of the company. It is essential for users to
understand the different environments that companies operate in when using ratios to analyze the suitability of
an investment.

NPV, IRR and Payback

Period
Posted by The Solar Labs on July 12, 2018 | 1 Comment
By Siddharth Gangal and Aarushi Dave
Your solar plant is an asset that makes you money. In fact presently, higher prices are
recorded for property with solar installation! While the journey to an installation may be
technically complex, there are financial details too that you must get clear.
As a consumer, viewing multiple quotes before making the purchase is critical financially.
However, we understand that all the metrics can be confusing, especially when you have to make
a decision.
The returns are measured by the Net Present Value (NPV), Internal Rate of Revenue (IRR) and
Payback Period. With this article, we aim to help you understand these terms, their implications
and attempt to make this journey smoother for you as a consumer.

Payback Period
As mentioned earlier, consumers might find all the parameters for judgement confusing. But one
the simplest one’s is Payback Period.
Payback Period is the time taken for a project to pay for itself i.e. time taken to recover the
cash outflow. It is the amount of time taken for savings made from the installed solar system to
equal the amount of money invested into the project.
However, it must be noted, that “simple payback period” does not consider inflation,
depreciation, maintenance costs, project lifetime, and other factors. For this, we use more
complex terms like NPV and IRR.
This means the true worth of your solar system over its lifetime is not obtained. Most
commercial installers take into account the net cost of the solar system after incentives have
been applied and divide it by your projected annual electric bill savings
To put it simply, if you have invested Rs. 2,00,000 into your initial installation, you earn Rs.
40,000 as savings each year, it will take you 5 years to recover the initial investment.
Therefore: Net Solar System Cost/Annual Utility Savings from Solar = Simple Payback in
Years
In fact, payback period is one of the easiest parameters to comprehend and very often consumers
rely on it for quote comparison. Let us dive right in!

Steps to calculate Payback Period:

1.Installation Expenditure = Total cost of Solar installation – value of upfront financial
incentives
The ‘Total cost of solar installation’ is the gross cost of installation of the solar system over your
property. The size of your installation and the various components are considered while
calculating this cost.
Upfront financial incentives are tax breaks and rebates.
2. Average Cost of electricity = total annual cost of electricity / total annual electricity
consumption
3. Yearly savings = average cost of electricity * yearly energy production from solar
system
The more energy you generate, the more you will save from your regular electricity bill.
4.Payback period = cost to install / yearly savings
The greater your yearly savings are, the shorter your payback period will be!

Net Present Value (NPV)

The next key criteria a consumer must be aware about is the NPV or the Net Present Value of the
installation.
NPV is how much return the solar plant will make, accounting for the time value of
money. Factors such as opportunity cost, inflation and risk are all accounted for in NPV to
give the overall value of the project in today’s time.
Hence NPV accounts for the “future value” of the investment made into an installation project.
Infact, ROI does not consider inflation, risk, or the lost opportunity of investing in another type
of investment, such as stocks and bonds. Thus, consideration of the “time value” of money is
the key difference between the two criteria.
This is similar to the analogy that a commodity worth Rs. 50 as of today will not be worth the
exact same amount in the future. It could amount to Rs. 51 or even Rs. 51.5 depending on factors
like inflation. Thus, if that project returned the same Rs. 50 to you at the end of a said time
period, it would not be profitable. But if it gave back Rs. 52, it would be profitable when
compared to the present value of Rs. 51 or Rs. 51.5.
A positive value for NPV indicates that the project is set to make money or prove profitable
to clients over the time period considered. Vice versa is the case for a negative NPV. Hence
this means that a project with a positive NPV is considered to be a “good investment” and is a
criteria for deciding whether to consider a particular project.
An important part of evaluating the NPV is the Discount Rate of a project. This is explained
ahead.

INTERNAL RATE OF RETURN (IRR)

The next important parameter a consumer must be aware of is IRR.
IRR or Internal Rate of Return is the discount rate at which the sum of Net Present Value
(NPV) of the current investment and all future cashflow (positive or negative) is zero. It is
an indicator of the growth of the project is expected to generate.
With regards to installing a solar panel system, the IRR is a criterion which indicates the returns
that your installation is expected to generate for you as an investor and serve as a benchmark
for future projects.
Hence the discount rate has an impact on the NPV of a project.
While all of this might sound too complicated, we will attempt to simplify it a bit.
NPV displays a particular project’s net present value in currency. Meanwhile, the IRR stands
for the rate of return on the NPV cash flows received from a solar investment. For example, if
the IRR of a project is 12%, it means that your solar energy investment is projected to generate a
12% annual return through the life of the solar system.
This makes IRR a useful parameter for comparing the returns different investment opportunities
and choosing rightly between them. This also means that on obtaining accurate data of each
investment, comparison between the IRR of investing in solar to the IRR of otherwise capital
investment can shed light on the one with the highest return. Or even help make a choice
between different solar projects.
How you choose to finance your commercial solar installation is one of the factors which
influences the calculation of the IRR.

If you choose to take a loan, data will include details such as:
1. The net cost of the system after upfront rebates and tax incentives
2. Debt amount
3. Interest rate present on debt
4. Debt term
5. Projected annual cash flow from utility savings
6. Pre-tax performance-based incentives plus O&M costs.

A glance at the IRR on a project is good indicator of the prospects of a project and should be
done before considering an installation.

The key differences between NPV and IRR :

Net Present Value Internal Rate of Return

1. Discount Rate that makes the Net Present
1. Calculated as the present value of cash inflow minus
Value (NPV) of all cash flows from a particular
the present value of cash outflow.
project equal to zero.
2. Expressed in the form of currency return expected 2. Expressed in the form of percentage returns
from a project. expected from a project.
3. Absolute Measure: Currency value gained or lost on a 3. Relative Measure: Rate of return of a project
project. over it’s lifespan.

The calculations of both NPV and IRR are given here:

NPV Calculation:
Present Value = Cash Inflow or Future Value x (1 + rate)^-(time)
NPV = sum of all PV – Cash Outflow
If NPV > 0 accept

IRR Calculation:
Set NPV to zero
0 = [Cash Inflow x (1 + IRR)^-(time)] – Cash Outflow
When IRR > rate accept
The discount rate is a critical part of calculating the NPV. Higher the discount rate, lower is the
NPV.

So, let’s take a hypothetical example:

Say our solar system:
* costs Rs. 100
* returns Rs. 25 per year for 5 years
* discount rate of 5%

Therefore NPV
= 25*(1.05)^-1 + 25*(1.05)^-2 + 25*(1.05)^-3 + 25/(1.05)^-4 + 25/(1.05)^-5 – 100
= Rs. 8.236

And therefore, for IRR for 5 years

0 = 25*(1/(1+IRR)) + 25*(1/(1+IRR)^2) + 25*(1/(1+IRR)^3) + 25*(1/(1+IRR)^4) +
25*(1/(1+IRR)^5) – 100

IRR = 7.9%
So, for our example payback period is 4 years.
So, in both cases we should go ahead with the transaction.
Both NPV and IRR are criterion that could be used to evaluate how profitable a project is.
Calculating Net Present Value (NPV) and
Internal Rate of Return (IRR) in Excel
CFA EXAM LEVEL 1, EXCEL MODELLING

This lesson is part 5 of 9 in the course Capital Budgeting

Net Present Value (NPV) Function

The NPV function calculates the present value of a series of cash flows at
equal time intervals. The function is represented as follows:

= NPV(rate,value1,value2,…)

Here, rate is the discount rate for one period, and values are the cash flows.
Any payments are entered with a negative sign, and income is entered as
positive.

Note that even though the function is named Net Present Value (NPV), it
doesn’t really calculate the net present value. This is because it does not take
into consideration the initial investment at time 0.

To calculate the net present value, you will need to subtract the initial
investment from the result you get from the NPV function.

Lets take an example to demonstrate this function. Assume that you started a
business with an initial investment of $10,000 and received the following
income for the next five years.
To calculate the net present value, we will apply the NPV function as follows:

This is the present value of all the future cash flows.

The net present value will be:

Net Present Value = 11,338.77 – 10,000

= $1,338.77
Internal Rate of Return (IRR) Function

IRR is based on NPV. It as a special case of NPV, where the rate of return
calculated is the interest rate corresponding to a 0 (zero) net present value.

IRR function is represented as follows:

= IRR(values,guess)

This function accounts for the inflows and the outflows, including the initial
investment at time 0.

Using the same example above, the IRR calculation is shown below:

The IRR of 14.974% means that at this rate the net present value will be zero