What is a Baseline
A baseline is a benchmark that is used as a foundation for measuring or comparing current and past values. For example, a company wanting to measure the success of one of its product lines can use the number of units sold during the first year as a baseline from which to evaluate subsequent sales growth. The baseline can be considered the starting point against which all future values are measured.
BREAKING DOWN Baseline
A baseline is any form of measurement that is used for comparison and analysis. It is a clearly defined starting point from where a new strategy is implemented, an existing improvement is judged, or a comparison between two periods is made. For example, if a public company wants to analyze potential reasons behind positive or negative changes in its profits, it will choose one year as a baseline and judge all subsequent years against it.
A baseline is specifically used when a person or company is conducting a financial statement or budget analysis. A financial statement analysis uses ratios or accounting numbers as the baseline for financial performance. A budget analysis uses existing revenues and spending as the baseline for assessing whether or not the budgeted project is implemented successfully.
Baseline in Financial Statement Analysis
The financial statement analysis that uses a baseline is called horizontal analysis, which compares a company's historical financial information over a number of reporting periods (e.g., monthly, quarterly, or annually). The first period in a horizontal analysis is denoted as the baseline period. All subsequent periods are then measured as a percentage of the baseline. So, a period with the same revenue as the baseline would have 100% revenue.
The idea is to spot trends, look at growth, and assess financial performance. Ratios like profit margin are also compared horizontally against the baseline year to further analyze a company's performance.
Baseline in Budgeting
A baseline in project budgeting is known as a cost baseline. This type of baseline is an approved plan that outlines the cost of a project in detail, both by cost category and by the cost per period of time. The baseline budget is what the project's implementation is judged against. If a company is opening a new warehouse and the cost baseline is set at $100,000 a month for 10 months, any monthly cost exceeding $100,000 is a red flag.
However, project costs always fluctuate as unknown and unexpected expenses are realized. When these costs become unavoidable, the cost baseline can be updated to reflect the accuracy of the project's costs. The baseline can also be the point of reference for evaluating the project's effects on revenues and spending. If the cost baseline is too high for the expected revenue of the project, it is a red flag.