What is a Baseline in finance?
Generally, a baseline is used to establish comparisons of different entities; the same applies in finance. A baseline is also known as ‘base’. It is very well used in business operations and project executions especially when a company seeks to measure the progress of its profits or when the progress of a project is measured. Usually, both measures would be compared against a previous profit or a previous project to determine the progress of a current project or profit. The previous entity being measured against is called the baseline.
When a company wants to measure its profits to determine whether or not they are increasing or decreasing the company can decide to compare a current year’s profit with that of a previous year. Such that, the previous year’s profits are considered the baseline for the comparison. Another baseline instance can be seen when a company wants to measure the success of its product line. It can use the total number of sales per unit made of the first year and use them as a baseline to compare subsequent annual sales. It is important to note that the baseline is not limited to only the first year as the company can pick any previous year’s sales as the baseline for a current year as far as it perfectly serves the comparison purpose.
A baseline can be used to not only compare profits or product performance between years but also, track the progress of an ongoing project and assess the effect of a change. It is also used in budget analysis and financial statements by using existing revenue and spending as the baseline for evaluating the implementation of a new project. Baseline touches a range of areas such as finance, budgeting, and information technology amongst others. In financial analysis, the first reporting period serves as the baseline for comparison while in budget analysis the approved budget numbers serve as the baselines.
Baseline in Finance
In financial analysis, the act of using a baseline to measure performance is called ‘horizontal analysis’. Its duty is to compare the history of a company’s financial information over monthly, quarterly, or yearly reporting periods. The first period is referred to as the baseline period, following periods will be measured as a percentage of the baseline. The period that has the same revenue as the baseline period will have 100% revenue.
Baseline in Budget Analysis
In budgeting, the baseline is used to measure the budgetary effects of all proposed changes in budgeting and spending. As stated by the Government Accountability Office, it is “an estimate of spending of spending, revenue, the deficit or surplus, and the public debt expected during a fiscal year under current laws and current policy.”