Understanding Pro Forma: A Comprehensive Guide

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. Instead, it uses ongoing and recurring financial transactions to give you a clearer understanding of your business’s regular operating performance and financial position. They can help you make a business plan, create a financial forecast, and even get funding from potential investors or lenders.

As a slight aside, for more in-depth insights on pro forma adjustments as well as some handy best practices and examples, we urge you to look at our Ultimate Guide to Pro Forma Statements. For these walk-throughs, however, we’re assuming you’ve already looked over the different events and scenarios that can prompt pro forma adjustments. Pro Forma Financial Statements are an insightful way to investigate fictitious scenarios, but it’s important to remember that they are based on forecasts, prepaid rent and other rent accounting for asc 842 explained not facts. Therefore, it is quite possible that the predictions made by the Pro Forma Financial Statements will not be completely inaccurate and may have fallacies. Using this as a tool, your business can come up with optimistic, realistic, and pessimistic future scenarios for the future of the company. In other words, if you’re trying to attract investment capital or have an M&A transaction on your mind, you’ll want to use something more detailed and tailored for the purpose.

For example, considering that the value of land is not depreciated over time, the value of land will be the same as the original purchase price. Buildings and vehicles, on the other hand, are subject to depreciation, so you need to calculate their value. You need to subtract this from the initial purchase price to calculate the asset value. Creating pro forma statements is easy with dozens of free and paid tools available online. Here are some ways pro forma financials can benefit your company, no matter which stage of operation you’re at.

For this reason, professionals typically turn to forecasts and financial projections to guide their plans and answer critical “what if” questions. Pro forma financial statements are a common type of forecast that can be useful in these situations. For publicly-held companies, the SEC requires an introductory paragraph showing the proposed transactions, the company, the period covered, and what the pro forma information describes. The SEC also requires the pro forma balance sheet, pro forma income statement(s), and explanatory notes that provide adjustment justifications and pertinent detail. The pro forma financial information should be presented in columns and show the condensed historical amounts, the pro forma adjustments, and the pro forma amounts. GAAP-conforming financial statements must be included with pro forma submissions.

To Create Pro Forma Financial Statements – Balance Sheet

Stable businesses can generally estimate income tax expense as a percentage of income before taxes. To get sign-off from key stakeholders, win investors, and strategically plan, you need to demonstrate that your ideas make financial sense. For this reason, investors must examine not only the pro forma earnings, but also GAAP earnings, and never mistake one for the other.

Returning to the example of the proforma balance sheet, such financial statements should include the amount that the start-up should pay for the month for example the cost paid to consultants, marketing agents, team members, workers, etc. After the values of all these liabilities have been recorded, they must be added together to calculate the final value of the total liabilities. Both pro forma financial statements and budgets are an anticipation of the future and can decide you intend to spend your money. Budgets are formulated based on pro forma financial statements to plan based on expectations. Pro forma financial statements provide insights into the company’s historical health and focus on the company’s future.

  • Pro forma financial statements are not computed using GAAP and are often called non-GAAP.
  • Pro forma statements can also play a major role in getting your business financed.
  • It differs when you begin forecasting various line items and calculating how those projections impact your bottom line.
  • Balance sheets systematically organize your financial forecasts in a tabular format to help start-ups manage their assets better and achieve better future results.
  • Pro forma financial statements enable investors to do that with available information.

While pro forma often refers to assumptions about future events, it can also refer to financial reports with irregular transactions removed. For example, if a company experienced significant restructuring charges in a given period, a pro forma might show how the company would have performed if those charges never occurred. Looking at both best case and worst case scenarios helps you make financial decisions based on challenges you may face in the future. For instance, what happens if your main vendor raises their prices like they did last year? Or how will that proposed transaction of buying new equipment impact you long term? Risk analysis lets you take the future for a test ride, and try out different outcomes.

Why create pro forma statements?

Therefore, to paraphrase Merriam-Webster, pro formas involve or are based on a suggested idea or theory. Put another way, they use information that can vary substantially from actual data. So while pro formas are fantastic for looking at events from different angles, never take them as gospel, only well-informed conjecture. If it is negative, it means that you do not have enough cash on hand to run your business according and you may have to contact lenders or investors to out in your business. If the cash flow shows a positive figure, you can plan how to spend the surplus. You can either think of repaying an existing loan or saving by investing in the surplus.

As you might’ve noticed, we’ve used the word hypothetical several times already. And while pro formas can be enormously helpful in looking at different financial models based on various assumptions, they’re still – you guessed it – hypothetical. These are very useful business planning tools as they can be compared side by side based on various financial forecasts that will help you decide between two possible strategies.

Example pro forma cash flow statement

They’re not actual historical financials nor do they reflect current accounting standards that were followed by submitted audit reports; but rather predictions about how those standards would affect the company’s finances if implemented at some later date.. It’s important to note that while these projections may provide valuable insights regarding a company’s potential future success or lack thereof – they should never be treated as concrete fact without proper analysis and reasonable assumptions. The pro forma financial statements – balance sheet must contain current assets like accounts receivable and cash and then cover income that is within the scope of this financial statement. The claimed rationale should include the current income and the general schedule that follows the bill payment.

Pro Forma Statement of Cash Flow

Pro forma cash flow for the medium-term refers to estimating revenues for items that haven’t been billed as well as expenses needed to support the revenue. You can do this by referencing your order backlog for several future months, which are translated into cash receipts. Under standard Generally Accepted Accounting Principles, these nonrecurring restructuring costs would get posted on the company’s income statement, substantially reducing profits or maybe even showing losses. However, we only feel it right to issue a big ol’ caveat before we go any further.

Start combining all compiled information/variables + inputting summary-level tables crafted by financial professionals experienced enough they’ll likely lead trends driving effective numbers achieved. The preparation of pro forma statements in various economic environments is useful for management to examine the consequences of rises in expenses or economic downturns. With the best guesses of future results, managers can prepare budgets for all departments to deal with the expected conditions. Before delivering an actual invoice, send a client a pro forma invoice that lists the cost of the goods and services you’re planning to provide.

Future Proof Retail

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. Additionally, the SEC may require that pro forma financial statements be submitted when a company is filing for an initial public offering (IPO).

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. Pro forma financial statements can be invaluable tools for business owners when it comes to business planning. Pro forma financial statements enable you to project your business’s financial position, not just in the short term, but also years into the future. By using them, you can make better business decisions and plan more effectively. 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.

Example pro forma income statement:

Some candidates may qualify for scholarships or financial aid, which will be credited against the Program Fee once eligibility is determined. If you don’t know how each of the companies defines its pro forma figures, you may be comparing apples to oranges. Companies’ definitions of pro forma vary along with their internal methods for forecasting and making assumptions. Using pro forma results to grossly misconstrue GAAP-based results and mislead investors is deemed by the U.S. Securities and Exchange Commission (SEC) to be fraudulent and punishable by law.