Pro Forma: What It Means and How to Create Pro Forma Financial Statements

We strive to empower readers with the most factual and reliable climate finance information possible to help them make informed decisions. Go a level deeper with us and investigate the potential impacts of climate change on investments like your retirement account. It makes it possible to restate the financial elements and to make them consistent from one year to the next. The objective is to facilitate the analysis of an investor seeking to assess the future of a company on the basis of comparable elements. Let’s assume that you expect sales to increase by 10 percent next year.

Pro forma financial statements give banks information about your ability to make payments while continuing to run your business. “The statements also provide them with the assurance that you understand the operations of your business and what can cause fluctuations in your earnings,” said Taylor. Now the income statement, balance sheet, and other data can be used to create the statement of cash flows. Pro forma is a Latin term that roughly translates to “as a matter of form,” and is most often used to describe a document that is based on financial assumptions or projections, such as a pro forma balance sheet.

How to Create a Pro Forma Statement

By outlining your sales, expenses, and profit, you can get a clear picture of your company’s financial health and make informed decisions about its future. Our team of experts has created a comprehensive business plan template that will guide you through the process of creating your own pro forma business plan. For example, if you make a sale today, it will be considered revenue in your income statement.

An owner may create pro forma reports to assess the potential profitability of a product, or to determine if a business expansion makes financial sense. Simply put, it’s a future or projected income statement, or it can even be used to restate financial books in an unofficial way. For example, a business may use a pro forma financial statement to show what a businesses profit was if it sold off an arm of the company. A pro forma financial statement is a document that shows the forecasted financial effects of a particular event or decision.

What are the benefits and limitations of pro forma financial statements?

To illustrate why this distinction matters, let’s imagine you and I start a business, and in the beginning, we expect sales to be relatively low; say one hundred units. Fixed costs stay relatively constant – at least for a while – and are more important in the beginning because they’ll make up a higher percentage of overall costs. There are many different revenue drivers, but our chosen method for generating new business should be appropriate for the amount we charge customers. We don’t want to spend three months courting a new client to sell them a $20 product. Alternatively, we likely won’t sell a $100,000 service with a couple of Google ads – although it could be the first step. When we know how many units we need to sell, we may get a clearer picture of what else we need to do.

• Additionally, the SEC may require that pro forma financial statements be submitted when a company is filing for an initial public offering (IPO).
• These statements are used to present a view of corporate results to outsiders, perhaps as part of an investment or lending proposal.
• It differs from the regular income statement as the pro forma focuses on the future, while the former includes historical figures.
• This can prompt a warning signal for the stakeholders about the vulnerability of the company’s position if a worst-case scenario occurs for a company.
• In this way, your management team (or C-suite) has all the information they need to make informed decisions.

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. A pro forma balance sheet is an estimate of your company’s financial position at a specific point in time.

Pro Forma Statements

This pro forma balance sheet can also be used for corporate retail or wholesale businesses. While they all fall into the same categories—income statement, balance sheet, and cash flow statement—they differ based on the purpose of the financial forecast. The income https://www.bookstime.com/ statement reflects a company’s financial performance for the last financial period. Companies may also prepare a pro forma income statement to predict future revenues and expenses. However, its format may differ from one company to another based on their needs.

You can use them to study how changes in the price of labor, materials, overhead, and the cost of goods affect the bottom line. Use these models to test the goals of a company’s plan, provide findings that may be understood, and offer better, more accurate data than other methods. New financial models use computer programs that has made this testing better, which enables quick calculation for real-time decision making.

Definition of Pro Forma Financial Statement

We may bring in $15K per month, making 300 cold calls a day, but we won’t be able to make $150K per month making 3,000 cold calls each day because it probably isn’t possible. If we want to extend this forecast further into the future, we simply focus on increasing our revenue-driving activities (as long as they’re working). Once we have some reasonable assumptions regarding how many customers we’ll acquire, how much money they’ll pay, and when they’ll pay, we should have enough information to calculate revenue. When we have some idea of how we’re going to drive sales, we can look at how the transaction between the business and the customer occurs, which is a critical part of our revenue model.

There are several different types of financial statements that a company will create to understand how well they are performing financially. Therefore, there are many types of pro forma financial statements that a company can prepare for future reference. 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.

Finally, in each page of the pro forma information, there must be a reference to the compilation report. GAAP enforces strict guidelines when companies report earnings, while pro forma figures are better thought of as hypothetical earnings. As pro forma forecasts are hypothetical in nature, they can deviate from actual results, sometimes significantly.

While GAAP is required to create financial statements for publicly traded companies, pro-forma statements do not need to follow GAAP, as they are used internally or simply to estimate changes. You may be courting investors or trying to convince your business partners of the value of a capital investment or additional financing. In that case, you can use a financing pro forma projection to make your case.

Using pro forma results to grossly misconstrue GAAP-based results and mislead investors is deemed by the U.S. Securities and Exchange https://www.bookstime.com/articles/pro-forma-financial-statements Commission (SEC) to be fraudulent and punishable by law. By using this site, you are agreeing to security monitoring and auditing.

A budget anticipates the inflow of projected revenues and the outflow of funds for a defined future period, usually a fiscal year. The second section, Operating expenses, includes the costs of running the business. Hopefully, these costs are necessary, but they aren’t directly involved in producing or delivering goods or services to customers. The first section, Costs of goods sold, includes the direct costs of producing revenue. Without the expenses in this category, we simply couldn’t offer goods or services to customers. In the image above, we can see that variable costs are a relatively small percentage of total costs because we’re not selling much.

What are Pro Forma Financial Statements?

If we don’t expect to hire any new employees, it doesn’t make sense to use a percentage of revenue to forecast salary costs. If we need to forecast our pro forma over multiple future periods, say on a month-by-month basis over the next few years, we use the exact same approach detailed above. Once we’ve converted all costs into a percentage of revenue, we simply multiply each one by the forecasted revenue to get our costs for the pro forma.

There are no universal rules that companies must follow when reporting pro forma earnings. This is why it is important for investors to distinguish between pro forma earnings and those reported using generally accepted accounting principles (GAAP). These are models that forecast the expected result of the proposed transaction. For example, a company will report its actual sales and expenses for the quarter that just passed and, in the same chart, will list its projections of these numbers for the current quarter. A budget is based on certain assumptions about future expenses and revenues. It takes into account past expenses and revenues and factors in the costs of the company’s plans for the fiscal year.