What Is Base-Year Analysis?
In finance and economics, base-year analysis includes all of the layers of analysis concerning economic trends in relation to a specific base year. For example, a base-year analysis could express economic variables relative to base-year prices to eliminate the effects of inflation.
When analyzing a company's financial statements, it is useful to compare current data with that of a previous year or base year. A base-year analysis allows for a comparison between current performance and historical performance. With historical context, a business analyst can spot trends helpful when allocating resources to areas requiring additional help or areas experiencing growth.
- Base-year analysis uses a baseline time period against which other periods can be measured.
- Usually, an index is created where the base year is set to a value of one or 100.
- Base-year analysis is often used when apples-to-apples comparisons want to be made across time.
- A common example of base-year analysis is when looking at "real" economic data like GDP, which accounts for inflation or uses constant dollars.
Understanding Base-Year Analysis
A base-year analysis of a company's financial statements is important when determining whether a company is growing or shrinking. If, for example, a company is profitable every year, the fact that its revenues are shrinking year-over-year may go unnoticed. By comparing revenues and profits to those of a previous year, a more detailed picture emerges.
When performing a base-year analysis of any variety, it's important to adjust an analysis for any regime changes. Common regime changes include a range of macro, micro, and industry-related factors. For example, changes in accounting methods, the tax code, political party control, demographics, and social and cultural shifts.
The financial crisis of 2009-2010 is a good example where a base-year analysis that is not adjusted for a regime change is problematic. For instance, in response to sharp declines in housing values, many banks in the U.S. accepted government lifelines, as well as changes in accounting methods (i.e., the suspension of market-to-market accounting). An analysis using 2009 as a base-year is going to be overwhelmed by the significant market disruption experienced during that time.
There is no universally accepted "base-year," every analysis will include a different base based on the particulars under review.
Example of Base-Year Analysis: Real GDP
Often, a base-year analysis is used when expressing gross domestic product (GDP) and is known as real GDP when referred to in this way. By eliminating inflation, the trend of economic growth is more accurate, as price level changes are accounted for.
A simple formula would look like the following:
Real GDP=Nominal GDP∗CPIbaseCPIreferencewhere:Real GDP=Inflation-adjusted GDP,expressed in terms of the reference year’s dollarsNominal GDP=GDP expressed in terms of the base year’s dollarsCPIbase=A price index for the base yearCPIreference=A price index for the reference year
Let's consider a hypothetical country, Investopedialand. If we take the year 2010 to be our base year, with nominal GDP of $10.2 trillion and a consumer price index of 169, and we want to compare that in inflation-adjusted terms to the 2021 GDP of $20.5 trillion, when the consumer price index (CPI) was 248, we can calculate the 2010 real GDP in terms of 2021 dollars as follows:
$10.2 trillion∗248/169=$15.0 trillion
What Are Constant Dollars?
Constant dollars account for the effects of inflation over time by establishing a base year. For instance, if we want to talk about real incomes in the U.S., we may set everything to "2020 dollars" to make like comparisons across different years.
What Is the Base Year for the Consumer Price Index (CPI)?
The consumer price index (CPI) is a standard measure of consumer price changes that represents inflation in the U.S. Currently, the CPI base year is set to the average values observed over the period of 1982-1984, with an index value of 100 for that period.
What Is the Base Year for the U.S. GDP?
When calculating real GDP in the U.S., the year 2012 is currently the base year, and indexed to 100 for that year.