A guide to analyzing trends in your business

Continuing on the theme of financial analysis this week – we've already dug into the Monthly Financial Review and Rolling 12-Month Analysis – this week we'll work on spotting trends in our business...

A recap from last week's Financial Review post – we're honing in on #3-5 from that checklist:

There are 2 types of trend analysis we'll look at in this post:

1. Horizontal analysis – looking at trends over time (left / right)
2. Vertical analysis – looking at trends within a single period (up / down)

As a reminder, you can look at any metric (financial or otherwise) using horizontal or vertical analysis... it could range from sales to utilization to leads to cash flow.

Horizontal Analysis (left / right) — Is the metric you're reviewing trending up or down over time? That's all there is to it. This is really useful to spot patterns or trends in business.

Here's a sample (from a real company) which highlights revenue and gross margins over time [side note: this is in a rolling 12-month format, so we're stacking tools here!]

This trend should be obvious — Revenue is trending higher but gross margins are continually declining. If this were my business, I'd drill deeper into gross margins to see what can be fixed.

I use the horizontal tool on a near daily basis. Some trends are slow moving and others are rapid. My goal is to surface any problems quickly and share them with the team or clients.

Some examples for how I use it:

• Cash management
• Turnover or days ratios
• Labor efficiency tracking
• Sales trends for a new product or service
• Monthly margin trends (gross margin, net margin)
• Adding an average or median as a baseline (see video below)
• KPIs for sales or operations (leads, impressions, response time)

Vertical Analysis (up / down) — Sometimes referred to as common-sized financial statements. This approach takes each line item on a P&L or balance sheet and divides it into another number. For example, all lines on a P&L divided by revenue or all lines on a balance sheet divided by total assets.

This gives you a percentage-based look at how the pie is split in a single period. For example; if revenue = 100%, then maybe COGS = 40%, rent = 10%, overhead labor = 15%, marketing = 10%, and everything else = 5%... that leaves you with 20% net margin. The same process works on the balance sheet too.

By itself, the vertical analysis is a bit less useful, but there are 2 good ways to use it:

1. Plot vertical ratios over time and use with a horizontal analysis. Again, look for trends and patterns.
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2. Compare your vertical analysis with industry benchmarks. Are peers operating with 5% marketing expenses to your 10%? That's useful information!

Here are the main takeaways:

• Horizontal = over time (left / right)
• Vertical = within a period (up / down)
• The object of the game is to identify patterns and trends
• Don't force an outcome either; if there's no trend (i.e. a metric is flat or consistent), then consider it a "check the box" exercise and revisit it another time

Bonus — Here's a video tutorial on graphing the inventory turnover metric over time (horizontal analysis):

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Homework

You guessed it — give both of these analytical tools a try.

You're probably already doing horizontal reviews on a regular basis by looking at monthly or quarterly P&Ls. This time try to spot a pattern or trend in your business (there's likely at lease one).