In creating your pro forma documents, it is advisable to create multiple sets with different scenarios, especially when their purpose is to help make decisions. In this way, your management team (or C-suite) has all the information they need to make informed decisions. 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.

A pro forma cash flow statement forecasts the net cash flow of a company for future periods. This statement focuses on the expected inflows and outflows of cash, helping businesses project their liquidity. By understanding the projected cash flow, companies can ensure they have enough funds to cover operating expenses and potential investments. Pro forma income statements may be used for a variety of purposes including budgeting, financial planning, and forecasting. They may also be used by lenders and investors to determine a company’s financial health and growth potential.

These statements take into account historical financial information as a base and adjust for transaction accounting adjustments, proposed changes, or hypothetical scenarios. Pro forma financial information is typically used to inform investors, lenders, and management about potential outcomes based on certain assumptions. Pro forma earnings per share (EPS) are calculated by dividing a firm’s net income (and any adjustments) by its weighted shares outstanding, plus any new shares issued due to an acquisition. 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 what is a pro forma income statement be used to fund dividends.

Step 2: Define Assumptions and Adjustments

Companies may be tempted to present pro forma statements in a way that paints a rosier picture than reality, potentially misleading stakeholders. Cash flow statements are particularly important for financial planning as they provide insight into how the business will finance its operations, pay off debts, and manage capital expenditures. Using tools like forecasting and scenario planning, decision-makers can estimate the organization’s future financial position and determine actionable strategies to optimize performance.

  • Unrealistic assumptions will lead to inaccurate and unreliable pro forma statements.
  • These hypothetical conditions are then used to project the most likely outcome for a series of corporate results.
  • The pro forma income statements considers past data, but its projections reflect the addition or subtraction of events or things.
  • These ratios, derived from balance sheets and income statements, can be compared to industry benchmarks to understand how the business is performing against competitors.

Successful SMBs use financial tools to forecast business performance based on assumptions. Pro forma statements typically project 1-3 years into the future, but this can vary depending on your business goals or the type of forecast needed. You can address this fact simply with a final paragraph in the compilation reports, and the author may elect to include the reason for the lack of independence.

The difference lies in the assumptions and adjustments made about various inputs, while the format and calculations remain the same. Similarly, pro forma statements are used to help executives evaluate potential business decisions. For example, a manufacturer might create pro forma statements to compare the financial impact of building a new factory versus outsourcing production. This document is like the hydration strategy for your marathon; it tracks the flow of cash in and the cash disbursements out of your business.

If a company division is losing money, pro forma reports can estimate the cost of closing the division completely. Management may decide to operate at a loss until long-term liabilities, such as lease agreements, are paid in full. Assume a new product launch will increase revenue by 15% in the next fiscal year. Pricing is based on high demand for the product, and if the cost of sales is controlled, the company’s profitability moves higher. Publicly traded companies must use GAAP statements for official reporting to investors, regulators, and tax authorities, as required by law. These statements must follow strict accounting rules to ensure transparency and consistency.

Creating Reliable Pro Forma Financial Statements

Here’s a closer look at what pro forma financial statements are, how they’re created, and why they’re a key aspect of financial decision-making. You may be courting investors or trying to convince your business partners of the value of a capital investment or additional financing. It takes into account an injection of cash from an outside source—plus any interest payments you may need to make—and shows how it will affect your business’s financial position. While this might give a clearer picture of regular operations, it could also make the company’s financial health appear better than it is. From here, too, it’s also pretty apparent how pro forma statements can be used to shift enough into supposed “one-time costs” so as to be misleading—which is against the law. For example, if a company spends $50 million restructuring its business, GAAP rules require this cost to be included in earnings.

Cash flow statement

Finally, in each page of the pro forma information, there must be a reference to the compilation report. 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 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. On the other hand, if net cash flow is positive, you can plan on having enough extra cash on hand to pay off loans, or save for a big investment. Although it provide a better picture, it is prudent for the investor to dip deep and analyze what is included/excluded and why so?

Business Insights

They tend to leave out one-time expenses that are not a part of the day-to-day company operations. For example, they would generally leave out expenses such as restructuring costs. Going back to our Wal-Mart example, let’s assume the company can’t support that many purchase orders and has to draw a line of credit in order to fund it.

  • We used local population data and identified coffee consumption trends to project potential sales growth.
  • For her cash flow projections, she considers the timing of her investment and the gradual increase in sales.
  • Businesses use these statements to make financial assumptions about future performance and financial results.

Example of pro forma balance sheet

Our easy online application is free, and no special documentation is required. All participants must be at least 18 years of age, proficient in English, and committed to learning and engaging with fellow participants throughout the program. Our easy online enrollment form is free, and no special documentation is required.

It shows everything your company owns (assets) and owes (liabilities), plus equity, at a specific point in time. This centralized source of accurate data allows you to quickly compare forecasts, budgets, and business plans and prepare accurate pro forma financial statements that are realistic for business planning. For example, companies can use pro forma income statements to project potential revenues and expenses after launching a new product or entering a new market. They create pro forma statements combining their own historical financial information with that of the acquisition target.

A pro forma income statement offers insight into a company’s potential profitability. It also helps them tweak plans and actions anticipating specific outcomes, such as new market conditions, pricing, or operational costs. 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. The future is inherently uncertain, and pro forma statements are based on assumptions about future events and conditions.

As such, it’s a useful tool that business owners may use to estimate what their future expenses, revenue, and profits will be. While pro forma financial statements are useful for planning and decision-making, they are not typically used for tax purposes. They are primarily intended to provide insight into future financial performance rather than to calculate taxable income. Pro forma balance sheets are valuable when evaluating the effects of significant capital expenditures, acquisitions, or other business combination events on the company’s financial health. They provide a snapshot of the company’s future financial status, helping management and investors assess the impact of business decisions. A pro forma balance sheet projects the company’s financial position in the future, including assets, liabilities, and shareholders equity.

From the Latin meaning “for the sake of form,” pro forma generally means something done for the sake of appearances, or formality. In finance, pro forma statements are projected, hypothetical views that reflect “what-if” scenarios. Let us look at the various types of the pro forma income statement in business plan. Luckily, if you are creating a pro forma for a new business, you can try our software, Poindexter, for free! We’ve made it easy to create pro forma financials in a fraction of the time, and it won’t require any special knowledge. We’re about to cover what a pro forma income statement is and how to create one for your business.