Farwah Jafri | October 27 2022
Pro forma is a Latin term which means “for form.” In short, the pro forma financial statements are the “what-if” statement generators. They allow you to explore different hypothetical situations and their impact on your business.
According to Harvard Business School, pro forma financial statements are “financial statements forecasted for future periods. They may also be referred to as a financial forecast or financial projection.”
Pro forma statements appear in the financial reports incorporating hypothetical data and estimates. Have a look in detail at what is meant by pro forma statements.
Pro forma financial statements are reports solely based on hypothetical situations regarding financial projections or assumptions. They are incorporated into financial reports to give a forecast about the projected profits of a business by excluding certain nonrecurring items.
Pro forma financial statements are useful for business owners, decision-makers, investors, or creditors. They might need them to examine different case scenarios for the future.
Managers also benefit from creating these pro forma reports as they enable them to understand different factors that may impact business operations in the future.
There are many reasons for preparing a pro forma financial statement. Some of them are:
– Pro forma statements are extremely helpful when it comes to business planning as they assist the business owners in conducting a comparison of the progress of the company and the projected financial presumptions. This can help in selecting a potential proposal for strategic business planning.
– Pro forma financial statements can also be utilized to foresee the impact of a financial decision on the business in the long run.
For instance, if a business is planning to refinance debt, pro forma financial statements can come into use by determining what effect the debt will have on the company in the long run.
– Pro forma statements come in handy when it comes to getting investment for the business. When a company plans to apply for an investment, the pro forma financial statement can be presented to showcase how you plan to use the capital for the sustainable growth of your business.
In most investment cases, the pro forma statements are considered a prerequisite for investment documentation.
Pro forma financial statements can be of various types. Let’s have a look at some of the examples of pro forma statements:
In this statement, the pro forma report excludes nonrecurring or unusual transactions. This excludes the expenses such as restructuring costs, declining investments, and other adjustments made on the business’s balance sheet, which fixes the accounting errors from previous years.
Pro forma accounting statements help in finalizing a proposal for a merger, acquisition, capital investment, or a change in the company’s capital structure.
This kind of statement informs the investors about the internal assessment of a prospective financial outcome because of a change in the business dynamics. This can be an acquisition or a merger.
A budget comprises assumptions and projections about future revenues and expenses. A pro forma budget statement anticipates the inflow of revenues and outflow of capital in a designated period of time, which usually is one fiscal year.
A pro forma income statement uses the pro forma method of calculation in order to draw the attention of prospective investors toward the specific income details mentioned in the quarterly business report.
For instance, in a quarterly earnings report, a company mentions the actual expenses and sales incurred in the quarter and will also list the projected numbers for the next quarter.
These statements play a crucial role in determining the future of a company. They help the management so they can come up with a decision or proposed action based on these projected figures.
There are certain limitations attached to pro forma financial statements. First of all, these reports are based on assumptions, and hypothetical data so they should not be considered facts.
Another limitation of pro forma financial statements is that these reports are not accepted by GAAP (Generally Accepted Accounting Principles). It is the set of standards that companies must follow for their financial reports in the USA.
In some cases, the pro forma financial statements can differ immensely from the GAAP-approved financial reports.
A pro forma financial statement can be made by hand or using basic online templates. If you plan to create it by yourself, follow these steps:
– Calculate the revenue projection of the business. This process is also known as pro forma forecasting. It would be best if you use realistic assumptions. Do the research and then determine what can be the annual revenue stream for your company.
– Estimate the total expenses and liabilities of the business. The liabilities may include lines of credit and loans. Expenses can be utilities, salaries, lease payments, insurance, permits, licenses, taxes, etc.
– You need to use revenue projection and total expenses to project future net income.
– Now you have to estimate the cash flows, this part of the pro forma financial statement is known as the net effect on the cash flow. As any kind of business changes are proposed to be implemented in the future.
The cash flow can differ from net income because of certain expenses and revenues, which are recognized after cash release.
The true importance of pro forma financial statements is beyond what is written in these reports. These statements play a crucial part in providing stakeholders, creditors, and investors the foresight to make strategic plans and vital business decisions.
Farwah is the Product Owner of Monily. She has an MBA from Alliance Manchester Business School, UK. She is passionate about helping businesses overcome challenges that hamper their growth, which is why she is working at Monily to facilitate entrepreneurs to efficiently manage business finances and stay focused on growth.