Why You Need Pro Forma Financial Statements

what is pro forma statement

A pro forma balance sheet is a comparison of a business’ assets and liabilities. The pro forma part of the balance sheet is a projection that looks ahead, assuming certain things will occur. Pro forma balance sheets are difficult to compile, but banks generally ask for them and they are important for showing your potential financial picture. They can show the projection of what money will be tied up in receivables, equipment, and inventory. Further, they can represent if your company could run out of money, and how much is necessary to keep it afloat.

The Securities and Exchange Commission takes a dim view of this kind of adjusted reporting, and has issued regulations about it in their Regulation G. Pro forma financials offer businesses ways to make realistic assumptions about future growth rates and costs. According to Johnson, this is useful when you’re seeking outside capital (either debt or equity) to grow. “Potential capital suppliers will carefully examine pro forma financial statements (and the critical assumptions used in creating them) before committing capital to the firm,” Johnson said.

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. This approach is useful for seeing how a prospective acquisition could have altered the financial results of the acquiring entity.

what is pro forma statement

The same holds true for the process of preparing income statements and cash flow statements. It differs when you begin forecasting various line items and calculating how those projections impact your bottom line. Traditionally, financial statement analysis is used to better understand a company’s performance over a specified period. While this provides insight into a company’s historical health, creating pro forma financial statements focuses on its future. For this reason, these reports can be leveraged in several ways, including analyzing risk, projecting investments, and showing expected results before the end of a reporting period. For cases in which your company is specifically seeking funding, you want to show your potential investors how the company’s financial results will change with their investment.

Pro Forma Adjustments

Once you’ve created your pro forma income statements, and cast your eyes forward to the future of your business, you can start planning how you’ll spend your money. So if you’re already using GAAP financial statements and financial reports, why would you go to the trouble of creating pro forma financial information? There are several situations where having a pro forma income statement or other report can come in handy. The pro forma balance sheet looks at a forecast after a change or proposed transaction, like financing, adding a line of credit, a big capital investment, or acquisition. It includes current assets and total liabilities, as well as accounts receivable, cash and cash equivalents, accounts payable, and inventories. According to the SEC, for public companies, a pro forma balance sheet should have the same dates, plus one year from the last submitted balance sheet.

For example, if a company is considering an acquisition or a merger, it may publish a pro format statement of the expected impact of the move on its future earnings and expenses. Pro forma means “for the sake of form” or “as a matter of form. » When it appears in financial statements, it indicates that a method of calculating financial results using certain projections or presumptions has been used. This is when you take the financial statements of your business and merge them with https://www.quick-bookkeeping.net/last-in-first-out-lifo-method-in-a-perpetual/ financial statements of the other to see what your previous year might’ve looked like and what it may look like in the future. These assumptions can be off by a little or a lot, but the bottom line is their outcomes should not be weighed too heavily in decision-making without other indicators to back up the assumption. And as we mentioned earlier, they are not in compliance with GAAP, which means they have to be labeled as pro forma and cannot replace formal financial statements.

  1. If you enable them, they have the best and worst-case scenarios that review the fiscal impact of their decisions and possible ways to mitigate risk.
  2. By contrast, pro forma financial statements are based on current financial statements and change based on events and assumptions.
  3. Learners enrolled in the course learn the language of accounting and how to create financial statements and forecasts to make strategic decisions.
  4. She’s written several business books and has been published on sites including Forbes, AllBusiness, and SoFi.
  5. So your business is chugging right along, and you’ve had great financial results for years.

Short of having a crystal ball, pro forma financial statements can help you predict things like net income and gross profit in the future. Using these financial statements, you can plan for the future and lower your risk, as well as attract investors or get approved for financing. Even public companies are not required to get their pro forma document audited by an independent auditor, according to the SEC. However, to comply with professional auditing standards, the documents can be audited at the request of the company or a third party. The SEC guides auditors to ensure that they do not take on too much responsibility for the company’s claims. Whether in an assurance that the company is financially sound, also known as a comfort letter, or through a compilation letter, the auditor is only responsible for ensuring  the financial statements are prepared correctly.

Linking the Three Pro Forma Financial Statements

In the event that the projected numbers show that profits are likely to drop, the pro forma statement allows a company to see the need for changes in its operations to prevent decreased profitability. The changes can include absorption costing and variable costing explained cutting costs or increasing the price of goods and services. Keep in mind that the general process of creating pro forma financial statements isn’t significantly different from that of creating traditional statements.

These are factually supported by the data from the original financial statements. 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. For example, if your company recently acquired or dispensed with another company, the assumptions would be the changes in finance expected. The limitations should discuss the challenges of predicting the financial future of a company.

A full-year projection is just what the name suggests—accounting for the current year. For example, if it’s currently April and you want to perform a full-year pro forma projection, you would account for all the financials up to April and project the remainder of the year. Creating pro forma statements is easy with dozens of free and paid tools available online. Do you want to learn more about what’s behind the numbers on financial statements? Here we’ll be covering definitions, uses, and benefits of pro forma statements. Also known as a profit and loss statement or P&L, this accounting document shows sales transactions and expenses, as well as cost of goods sold (COGS)/cost of services sold and projected net income and profit.

How to Create A Pro Forma Statement of Cash Flow

If, for example, it is preparing to produce new goods, the financial statements can help forecast if producing the new goods will cause expenses to increase. This enables the company to accommodate any potential for profit/loss by changing production strategy, materials, or even the rate at, or timing of, the production of the goods. You create a pro forma cash flow statement much the same way you’d create a normal cash flow statement. That means taking info from the income statement, then using the cash flow statement format to plot out where your money is going, and what you’ll have on hand at any one time.

A company may be seeking funding, and wants to show investors how the company’s results will change if they invest a certain amount of money in the business. An investment pro forma projection may result in several different sets of pro forma financial statements, each designed for a different investment amount. Planning and budgeting for business changes play crucial roles in operating a successful company. However, balance sheets, income statements, and similar finance-tracking documents focus only on the history of transactions and the current economic status of your company. A full-year pro forma is a projection of a company’s year-to-date results, to which are added expected results for the remainder of the year, to arrive at a set of full-year pro forma financial statements. This approach is useful for projecting expected results both internally to management, and externally to investors and creditors.

Pro forma financial statements incorporate hypothetical numbers or estimates. They are built into the data to give a picture of a company’s profits if certain nonrecurring items are excluded. In financial accounting, a pro forma earnings report excludes unusual or nonrecurring transactions.

Investors should be cautious when evaluating these types of statements because they present a considerably more favorable picture of the business. Accountants prepare financial statements in the pro forma method ahead of a proposed transaction such as an acquisition, merger, a change in a company’s capital structure, or new capital investment. Most businesses have limited resources, and pro forma reports can help you make better decisions with what you have. Pro forma statements are useful with regard to tracking future financial direction and occurrences, often including some historical numbers to help account for what the projected outcomes should look like.

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