Pro forma financial statements can be invaluable tools for business owners when it comes to business planning. They’re often used for formalized future planning by larger businesses. 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.
However, creating and comprehending pro forma financial statements can be challenging, especially if you don’t have prior experience. This guide is designed to help you get a solid grasp of financial statements in general, making it easier for you to understand and master pro forma statements.
What is a pro forma financial statement?
A pro forma financial statement is a way of projecting future financial results using estimated data. The term "pro forma" means "as a matter of form," indicating that these financial information statements are more for planning purposes and are not intended to reflect historical data.
A pro forma financial statement doesn’t include one-time expenses. Instead, it uses ongoing and recurring financial transactions to give you a clearer understanding of your business’s regular operating performance and financial position.
Pro forma statements do not follow Generally Accepted Accounting Principles (GAAP), since they don’t use historical data. But they’re great for financial forecasts and projections, making them valuable for future planning and decision-making.
When you use pro forma financial statements, you gain insights into the potential outcomes of your actions — which helps you make better choices to drive the success of your business.
Reasons to use pro forma financial statements
Most businesses use pro forma financial statements to guide or support their financial decisions. Other common scenarios that can prompt companies to review a pro forma statement:
- Financial decision-making
- Debt refinancing
- Obtaining financing based on expense forecasts
- Future planning, considering best and worst-case scenarios
- Evaluating the financial impact of large purchases on the budget, such as real estate
- Comparing financial statements, such as balance sheet vs pro forma balance sheet
- Company restructuring
- Company merger
Disadvantages of a pro forma statement
Although pro forma statements have advantages, they have limitations and downsides. The biggest concern is they could end up being inaccurate. After all, the statements are projections, which are essentially guesses about the future.
It’s nearly impossible to predict what will happen with the world. No one knows what the future holds, and many things that can affect the company are out of your control (for example, the economy, a pandemic, war, an industry downturn).
But an unpredictable future isn’t the only problem. You could also miscalculate the projections. Your pro forma statement won’t be accurate if you miscalculate depreciation, income taxes, amortization, unsold inventory, or other figures.
Pro forma financial statement documents
Pro forma financial statements are made up of three primary documents:
- pro forma income statement
- pro forma balance sheet
- pro forma statement of cash flow
Pro forma income statement
You might know a pro forma income statement by its other name, pro forma profit and loss. Keep in mind that past income statements play a small part, so it’s essentially an estimate based on a best guess of the future.
Pro forma income statements include the cost of goods sold and operating expenses. It can also cover any number of years, and the period can depend on why you’re creating it in the first place. The four most common reasons to make a pro forma income statement are to:
- attract potential investors
- analyze risk
- assess potential limitations
- calculate financial ratios
Pro forma balance sheet
A pro forma balance sheet shows what your future balance sheet may look like and can summarize your total assets and total liabilities. Banks and lenders often use them to project a business’s financial stability. Because pro forma balance sheets can showcase a company’s five-year projection, it’s also helpful for business planning.
Pro forma statements of cash flow
A standard cash flow statement shows the actual cash inflow and outflow, while a pro forma cash flow statement forecasts the expected cash coming into and out. You can use different strategies to create a pro forma cash flow statement, depending on how far into the future you want to look:
- Short-term statements: Often prepared daily, weekly, or monthly
- Medium-term statements: Statements that project less than a year into the future
- Long-term statements: Prepared for periods beyond one year
Although pro forma cash flow statements are prone to inaccuracies, they have many benefits, such as:
- Financial decision-making: Pro forma statements can help you evaluate your business’s financial position and determine if you have enough funds to support your plans, including large purchases.
- Business modeling and planning: They assist in modeling various scenarios and contribute to comprehensive business planning, so you can better prepare for the future.
- Improved financial reporting accuracy: They allow for better analysis and evaluation of your business’s cash flow situation.
- Better financing opportunities: They can showcase your projected cash flows and the feasibility and potential profitability of your plans, which can attract financing and potential investments.
Creating a pro forma statement
You have a number of options for creating pro forma statements. Some businesses use forecasting software, while others prefer Excel. Either way, you’ll need to understand your revenue, costs, and liabilities. You can also use Xero software to create a pro forma statement.
Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the content provided.
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