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A base year, or reference year, is a year used as the measure against which to compare data from a different year. The data compared can be price, value, costs, or any other type of performance measure. Use of this method allows the analyst to normalize results over time by putting the data in a context that relates to the value of the reference. It controls for time-related factors, such as inflation, allowing disparate data to be compared on common footing.
There are a number of contexts that employ a base year to aid in the comparison of information. Finance, real estate, and economics are just three examples of industries that use the concept extensively. In finance, a base year is used to measure the performance of stock indexes over time. The financial analysts select a reference year and set the index's value in that year equal to 100. Changes in the value of the index in subsequent years are expressed in terms of its percentage higher or lower than the standard mark.
In the real estate industry, a base year is used as year one in commercial leases to determine the increases in common costs the tenant should pay every year. The expenses in a subsequent year are expressed as a percent increase over the year one expenses. Instead of trying to parcel out expenses to tenants, the landlord applies a comparison approach. If the common expenses have increased 20 percent over year one, the tenant's payment also increases by twenty percent.
The base year approach is extensively used in economics to control for inflation and other market conditions that affect price and value over time. It helps distinguish between real and nominal prices or values. Nominal values are expressed in terms of the cost of an item if money was used to purchase it in a particular year. The real value is controlled for time by expressing the price of the item in any year in terms of what the price would be in the base year.
This method is used to establish national standards to evaluate the performance of the economy, such as the consumer price index (CPI) in the US. The gross domestic product (GDP) of a country is also calculated using a reference year to normalize prices over time. This way of comparing data is so ubiquitous that it is used in matters great and small, from the analysis of housing markets to the determination of eligibility for unemployment benefits.
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