Pro Forma Financial Statements

Pro forma financial statements are a great tool to evaluate alternatives. Most businesses have limited resources, and pro forma reports can help you make better decisions with what you have. Financial statements, including the balance sheet, income statement, and cash flow statement, based on a set of assumptions. If, for example, you want to calculate the impact on the debt-to-equity ratio in future years, you can use the data from pro forma reports. A pro forma income statement would show how the company’s revenues and expenses might change and ultimately affect company profits. Income statements would show how much it would cost a company to pursue the project and how much revenues might improve after completion.

• Pro forma financial statements are made with a optimistic mindset of future success.
• The most common pro forma financial statements are projected balance sheets, income statements, and cash flow statements.
• Based on the specialty or geographic area, additional assumptions may be needed to properly project expenses.
• Finally, you should look at the company’s cash flow to make sure that it will be able to cover its expenses in the future.
• Pro forma statements can be created for all three types of financial statements.
• Keep in mind that the general process of creating pro forma financial statements isn’t significantly different from that of creating traditional statements.
• U.S. public companies must follow GAAP for their financial statements.

Still, they can be useful in helping you to see how the future may look. Explain how Pro Forma Financial Statements can be used to project future scenarios for the planning process. Russell creates a pro forma income statement for next year to inform his decision. Russell follows The Ascent’s guide to forecasted financial statements to generate the document. If you take out the loan, you might share the pro forma financial statements with the lender to demonstrate your ability to repay the loan. Businesses also use pro forma financial statements to prod investors to provide capital. The purpose of a pro forma statement is to help management in making informed decisions about certain events or transactions.

Can you compare different companies’ pro forma statements?

For example, utilities may increase substantially in the summer for Doggie Dogs since their sales increase due to picnics, family reunions, and vacations. Calculate the net cash flow by subtracting total outgoing cash from incoming cash. But enough with what a “pro forma” is, you care about how to quickly create a Pro Forma Income and Financial Statement.

Infinancial accounting, pro forma refers to a report of the company’s earnings that excludes unusual or nonrecurring transactions. Excluded expenses could include declining investment values, restructuring costs, and adjustments made on the company’s balance sheet that fix accounting errors from prior years.

Pro Forma Adjustments

Each type of pro forma financial statement will be further discussed in detail; such as the pro forma cash flow statement, pro forma income statement, and pro forma balance sheet. To ensure that financial statements are reporting accurate information for public use, they have to follow generally accepted accounting principles, or GAAP. GAAP are strict guidelines that all businesses must adhere to in the United States when preparing their financial statements. Companies face heavy fines, sometimes in the millions, and even federal jail time for not following GAAP. A business is allowed to exaggerate and embellish their financial reporting because the pro forma statement is trying to predict what happens in the future. Potential and current investors use this information to decide where to spend their money. An investor is any individual or entity that has a financial stake in a business, with the expectation of a financial return.

If your company must produce an introductory paragraph with its pro forma documents, it should describe the content of your pro forma documents. This means that it should define the transaction, the entities involved, and the periods of time. In this paragraph, you should offer a high-level explanation of the limitations and assumptions the pro forma documents were produced under.

Benchmarking Data

A few weeks later, after Jack has created pro-forma financial statements for Doggie Dogs, he makes a recommendation to purchase the company. This portion of the pro forma statement will project your future net income, sale of assets, dividends, issuance of stocks, etc. To illustrate the process of creating pro forma financial statements, meet Sally, the owner of Centerfield Sporting Goods. Centerfield is a small firm that manufactures baseball gloves, and Sally is creating pro forma reports for the 2021 fiscal year. Some of the most commonly used financial statements for pro forma are the income statement, the cash flow statement, and the balance sheet.

When trying to make a decision on a company, it is good practice to also analyze the present standard financial statements, as well as pro forma financial statements. This way, one is able to see how successful or not a business actually is. More importantly, a person can compare these statements to get a better idea if the pro forma statements are likely or not likely to come true. Generally, pro forma financial statements tend to portray a business as being more successful than it really is, and having more financial resources available than may actually be the case. Consequently, investors should be extremely cautious when evaluating these types of financial statements, and spend time understanding how they differ from the issuing firm’s normal financial statements. If so, they may issue pro forma financial statements that include the corrections they believe are necessary to provide a better view of the business.

My Bank is Asking For Pro Forma Financial Statements

Should the company proceed to purchase the machinery, its effect on the revenues needs to be considered. For example, if a company wishes to buy new machinery, it would have to do that through financing. The preparation of Pro Forma Financial Statements is the same as preparing the regular statements. They provide a general indication of what the company is and what it aspires to be. First off, you’ll need to set a sales goal for the period you’re looking into. You could do this by growing your number of sales a fixed amount every month, or gradually increasing the amount of sales you make per month.

Small businesses with established business operations can create pro forma statements based on past financial information. Many of the items listed above are part of the GAAP, but not included in pro forma reporting, making it rife for possible deception. This discrepancy is part of the reason the distinction between pro forma and GAAP financial statements is important.

The Cash Flow Needed to Finance a Business

Your costs, on the other hand, will include items such as lease expense, utilities, employee pay, insurance, licenses, permits, materials, taxes, etc. Be sure to put a great deal of thought into each expense and keep your estimates realistic. It’s illegal for publicly traded companies to mislead investors with pro forma financial results that do not use the most conservative possible estimates of revenue and expense. She is an expert in personal finance and taxes, and earned her Master of Science in Accounting at University of Central Florida.

It may be tempting to think of a pro forma statement as the same as a business budget. But budgets and pro forma statements are two distinct financial tools. This portion of the pro forma statement will identify the net effect on cash if the proposed business change is https://www.bookstime.com/ implemented. Cash flow differs from NI because, underaccrual accounting, certain revenues and expenses are recognized prior to or after cash changes hands. Your financial projections don’t need to be extremely detailed in order to be considered valid by your bank.

The pro forma balance sheet displays information about everything a company owns and all debt that it owes. It also computes how much the company is worth, after total liabilities have been subtracted from total assets. Pro forma financial statements are best prepared before any major transactions are entered into, so that business decision makers feel more assured that they can meet company goals. This is called managerial accounting, or when decision-makers prepare financial statements to meet proposed company goals. The pro forma cash flow statement, income statement, and balance sheet should not be confused for standard financial statements, that also include the cash flow statement, income statement, and the balance sheet. Pro forma documents are statements that are based on interpretations of the future; not how well a company is financially performing presently. The phrase pro forma refers to the practice of estimating the progress of operations of a business.

If you own a business or manage the finances of an organization, you would often think of different possible outcomes for revenue, capital costs, investments, or profits based on certain assumptions. While actual financial statements show how a business has performed in the past, pro forma financial statements project how a business will perform using hypothetical scenarios.

Pro forma financial statements are used in a business plan to present the best-case, expected, and worst-case scenarios for a proposed transaction. With pro forma statements, businesses can better make assumptions on what decisions are best for the company, such as labor increases, production increases, or even expansion. If you are unsure about how to create pro forma financial statements, it is best to speak to a financial advisor. They will be able to help you create projections that are accurate and realistic. This will help the bank make a decision about your loan application and increase your chances of approval. To create the forward-looking pro forma income statement, you’ll need projections from all areas of the business including projected income from all sales channels and projected costs for all operating expenses.

• Investors should be aware that a company’s pro forma financial statements may hold figures or calculations that are not in compliance with generally accepted accounting principles .
• It is important to find a balance between these two extremes in order to give the bank an accurate idea of the company’s financial stability.
• Entrepreneurs must conduct a detailed marketplace analysis to review industries, companies offering similar products and other current economic information.
• For example, a pro forma financial statement may show how a business would perform if it secured a new loan.
• Pro forma reports can be used to forecast the future financial performance of a business, to assess the impact of a proposed business transaction, or to evaluate the financial health of a business.
• Below are the Pro Forma projections of the Income Statement of Alibaba.
• Assumptions form the bedrock of pro forma statements; hence, a reliable pro forma statement is a financial model prepared on the back of realistic and justifiable assumptions.

Pro forma is a Latin term that means “for form” or “in form.” In the context of financial modeling, pro forma usually refers to a forecast or projection of future financial performance. A pro forma financial statement is a document that shows how a company’s financial position would look if a particular event or transaction had occurred.

What’s the Difference Between Pro Forma and GAAP Financials?

Pro forma income statements usually project a minimum of three years, whereas regular income statements may just be the year prior or based upon a lender’s request. According to the SEC, when required for public companies, pro forma income statements are required for the fiscal year, but not for interim periods. However, for all regular income statements presented in a filing, there must also be a pro forma statement. This form may also be used for corporate retail or wholesale companies. Building accurate pro forma financials requires an in-depth financial analysis of your present business. When creating pro forma financial statements, ask an accountant to provide additional guidance. Before extending capital or credit, investors and lenders might ask for pro forma statements to understand your outlook on company performance.

Calculate the cost of goods sold and any operating expenses then subtract is from the sales. Financing activities includes a mortgage on a building with the monthly payments categorized as an outlay; whereas borrowing money from a financial institution would bring cash into the organization as a cash inflow. The answers to these questions will assist Jack in completing a pro-forma balance sheet.

For example, sales might be presented as 15% higher , 5% higher , 20% lower . If material costs increase sharply, or there is a shortage of labor, the cost of sales will increase. Next, add up all your operating expenses, as well as any other expenses like income taxes and cash disbursements. Then, list your outgoing cash flows, such as the cost of sales, salaries, etc.

Still, there may be some gray areas, so use caution when relying on future projections. Justin Pritchard, CFP, is a fee-only advisor and an expert on personal finance.

So, you multiply your historical salaries of $200,000 and your historical expenses of $100,000 by 105 percent each. Your pro forma salaries for next year will be $210,000 and your pro forma expenses will be $105,000. You then figure your pro forma total expenses by adding pro forma salaries and pro forma other expenses together. What you really want to do is take into consideration everything possible to project sales. All of these items should be carefully figured into creating sales projections.

In reality, events might significantly differ from what is expected and therefore in retrospect, the pro forma statements can be called out by the investors as highly inaccurate. Cash flow is king and knowing that a business will generate future cash flow based on underlying assumptions is critical for business survival. A pro forma cash flow statement is a financial report that shows projected cash flow generated from business operations. Create the first part of your pro forma financial statement which projects the company’s future net income. To do this, you’ll use the estimated revenue projections from step one above and the estimated cost and liability projections from step two above. Pro forma financial statements are made with a optimistic mindset of future success.

In this case, you’ll want to earn an additional $1,500 income every month, for 12 months. Let’s say you want to increase your income by $18,000 over the course of one year. Let’s assume that you expect sales to increase by 10 percent next year.

This pro forma balance sheet can also be used for corporate retail or wholesale businesses. Pro forma income statements, also called pro forma profit and loss (pro forma P&L), are projections based on your past income statements. Regular income statements, sometimes called statement of financial performance, are exacting, in that they reflect the exact income figures your company had in past years.