Pro forma financial statements: What to include + how to create

She knows this will require a significant investment and wonders if the numbers add up in favor of her vision. When I first ventured into the realm of business budgeting for my startup, I felt like a novice treasure hunter without a map. My quest for data led me down various paths, from scouring through forgotten files on my computer to diving deep into the depths of online research databases.

Pro forma financial statements are a common type of forecast that can be useful in these situations. For instance, a startup seeking venture capital funding may use pro forma financial statements to outline projected revenue growth, expenses, and potential return on investment. Likewise, a company looking to secure a bank loan for a new facility might provide pro forma statements to showcase its ability to meet debt obligations.

What is a pro forma financial statement?

Pro forma financial statements are very informative to the investors as it shows the various assumptions and projections for the Company’s financials. However, such statements could vary substantially from actual events and may be inaccurate. Although, using these assumptions is not fraudulent as pro forma earnings are not regulated.

Common Pitfalls When Creating Pro Forma Statements

The oversight led to a considerable underestimation of future liabilities (since the oven was to be financed) and, by extension, equity. Needless to say, I had to redo the entire analysis, a humbling reminder of the importance of double-checking your work and considering all aspects of your business operations. When projecting your assets, consider both your current resources and those you plan to acquire. Overestimating assets can lead to overly optimistic equity calculations, akin to thinking you can run a marathon without training. We used local population data and identified coffee consumption trends to project potential sales growth. By considering factors like the increase in remote workers seeking café spots and the popularity of seasonal beverages, we crafted a realistic revenue projection.

Other individual line items can also be easily forecasted, such as the cost of goods sold, since it can be assumed it will proportionally grow with sales. Line items like income tax proforma income statement expense, on the other hand, typically don’t change directly with sales. Stable businesses can generally estimate income tax expense as a percentage of income before taxes. This happens when the business plans to make some retrospective changes in the income statement.

Businesses can use these projections to set realistic financial goals and develop comprehensive plans to achieve them. These detailed plans help ensure that all aspects of the business are aligned with the overarching objectives, fostering a cohesive and strategic approach to growth. Pro forma financial statements are essential tools for businesses to plan and project their future financial performance.

Pro forma EPS are calculated in the pro forma income statement, but the figure is also used in the pro forma balance sheet and the pro forma cash flow statement, when necessary. According to the SEC, when the dividends from stock exceed or are planned to exceed the current earnings, the EPS must be calculated. The SEC assumes that that proceeds from any additional shares will be used to fund dividends. The Securities and Exchange Commission (SEC), the United States’ regulator of its stock market, requires pro forma statements with any filing, registration, or proxy statement. They have articles governing the preparation of pro forma financial statements for public companies. These are Regulation S-X Article 11, and Regulation S-X 8-05 for smaller companies from 17 CFR 210.

Specialized projections

Businesses can generate a pro forma cash flow statement on a retail location to compare lease payments and other costs with cash inflows from sales. Startups often have to raise additional capital to fund business expansion, and investors need financial reporting to evaluate the company. These financial projections include cash inflows from additional capital, and cash outflows for interest payments (if funds are raised using debt).

If their growth projections are based on landing a new client or project, they might include an estimated income statement to show the effects of the new project on the bottom line. A pro forma income statement displays a firm’s anticipated sales and revenue. It also highlights anticipated fixed or variable operational expenses and, in the end, displays the potential profits and retained earnings for a future financial quarter. Accordingly, the Company’s management can include or exclude line items that they feel may not accurately measure its estimates. Cash flow projections are another critical element, detailing the expected inflows and outflows of cash over a specific period.

Businesses also create a pro forma balance sheet and a pro forma cash flow statement. These three types of pro forma financial statements are used to generate financial projections and make business decisions regarding future periods. According to the SEC, this does not take the place of the pro forma balance sheet, but the pro forma income statement may be withheld. The difference is that the financial forecast details the company’s expected results of operations as a single-point estimate or a range.

• If debt is increasing at a much faster rate than assets and equity, the company may be too heavily leveraged.
• To get the most from your pro forma statements, base your assumptions on solid research and update them regularly.
• It combines these numbers to showcase what your financials would have looked like in the case that you combined businesses earlier.
• Failing to do so can perpetuate outdated assumptions that no longer hold true.
• I recall a time when I was helping a friend forecast the cash flow for their startup.

The pro forma balance sheet, on the other hand, predicts future assets, liabilities, and equity. It aids in assessing the potential financial stability of a business under different scenarios. By projecting the financial position at a specific point in time, companies can anticipate capital needs, evaluate solvency, and make strategic decisions regarding asset allocation and debt management. These statements project the company financial performance based on future assumptions or theoretical events. The pro forma income statement, for instance, estimates future revenues and expenses, offering a preview of potential profitability. This is invaluable for setting realistic revenue targets, expense budgets, and gauging overall financial viability.

• In more complex scenarios, payment may occur over multiple installments after negations, contracts, and delivery timelines.
• This forward-looking approach makes pro forma statements a valuable complement to GAAP reports, offering a more dynamic view of a company’s financial trajectory.
• Pro forma financial statements differ, based on the time period used and the data reported in each statement.

Including these components allows businesses to create a detailed view of their expected financial health, essential for effective financial forecasting and business planning. If you plan to acquire another business, this is the right pro forma statement for you. The Company can make assumptions like the net costs of acquiring the business, positives from synergies and intellectual property gains, and estimate the total impact on the financial statements. This method can also be used for a shorter period, like one year, giving details about the Company’s performance in case acquisition is made. This includes both fixed and variable costs, such as salaries, rent, utilities, and raw materials.

Pro Forma Income Statement

Pro forma financial statements are constructed with several integral elements that collectively provide a comprehensive view of a company’s projected financial health. At the heart of these statements lies the revenue forecast, which estimates future sales based on historical data, market trends, and strategic initiatives. This projection is crucial as it sets the foundation for other financial metrics, influencing everything from cost of goods sold to net income. Pro forma financial statements should adhere to Generally Accepted Accounting Principles (GAAP) in order to provide accurate and reliable information to investors and other stakeholders. All in all, the process of preparing a pro forma balance sheet is much the same as preparing a normal balance sheet.

Risk Analysis

This proactive approach to risk management helps companies prepare for unexpected challenges and maintain financial stability. Additionally, comparing pro forma projections with historical performance and industry benchmarks can provide valuable context for assessing the reasonableness of the assumptions and adjustments made. The balance sheet projections are equally important, encompassing assets, liabilities, and equity. These projections offer a snapshot of the company’s financial position at a future date, helping stakeholders understand the potential impact of strategic decisions on the company’s financial stability. For instance, an increase in assets might indicate successful investment in new technologies or facilities, while a rise in liabilities could signal the need for additional financing.

Forecasting Costs for New Businesses

By playing out different “what if” scenarios, you can prepare for the future with confidence, making strategic decisions that propel your business forward. Pro forma financial statements report on the balance sheet structure, profitability, and cash flow changes that a large transaction may produce. This post discusses pro forma financial statements and the common assumptions used to create the reports.

It looks at the likely amount of cash flowing into and out of the business over a future period, based on different scenarios. If you’re looking to learn about pro forma income statements, then you’ve come to the right place. In mergers and acquisitions (M&A), pro forma financial statements are essential for evaluating the financial impact of combining two entities.