No one can accurately predict the revenues to be generated or the expenses to be incurred at the end of any given period down to the dollar. However, a realistic forecast is still possible — and this forms the foundation of pro forma financial statements.
If you run a business or are in charge of an organization’s finances, you likely think about revenue, capital costs, investments, or profits in terms of different possible outcomes based on specific assumptions.
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.
What are Pro Forma Financial Statements?
At their core, pro forma financial statements are reports created on hypothetical assumptions.
For example, in creating a pro forma income statement, you need to forecast future revenue.
This is accomplished by forecasting last year’s sales, orders for products or services in the upcoming period, or any backlog orders still to be completed. This forecast projects realistic revenue, which can be utilized in a pro forma income statement.
Pro forma statements are helpful financial planning tools that provide a numerical perspective of a business’s financial position and performance in future periods.
Sometimes, pro forma financial statements are simply altered or restated actual financial statements to show the impact of one-off financial decisions.
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Types of Pro Forma Financial Statements
There are three main types of financial statements: the statement of financial position, also known as the balance sheet, the income statement (also known as the profit and loss statement), and the cash flow statement.
Pro forma statements can be created for all three types of financial statements.
1. Pro Forma Balance Sheet
A pro forma balance sheet typically has all the components of an actual balance sheet.
However, the major difference is that some or all key figures in pro forma statements have been forecasted based on expected events. Still, some people interchange the terms ‘pro forma balance sheet’ and ‘balance sheet forecast.’
A pro forma balance sheet shows a business or organization’s forecasted assets, liabilities, and equity position at any given period.
The pro forma balance sheet also helps a business forecast the outcome of a merger, acquisition, or significant capital expenditure, allowing management to plan accordingly.
It offers insight into how various decisions affect liquidity, solvency, and future liabilities.
As a tool for forward-looking analysis, the pro forma balance sheet becomes an aid to strategic planning because it can help a company identify financial red flags.
2. Pro Forma Income Statement
Correctly estimating expenses, revenue, and profit is imperative for financial planning and management. A pro forma income statement is instrumental in this process.
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.
They can also help businesses compare a range of possibilities by creating different versions of a pro forma income statement.
For example, they can use pro forma income statements to compare outcomes with or without launching a product or with or without entering a new market.
This helps companies make decisions that are more likely to benefit their financial position. These decisions also help them minimize risk by looking ahead and anticipating a strategy’s potential financial consequences.
3. Pro Forma Cash Flow Statement
Cash flow is king, and knowing a business will generate future cash flow based on underlying assumptions is critical for business survival.
A pro forma cash flow statement is a financial report that shows projected cash flow generated from business operations.
Organizations can create a pro forma cash flow statement using either the direct or indirect method of cash flow reporting.
A direct method of preparing a pro forma cash flow statement involves itemizing forecasted cash inflow from customers or other sources and cash outflow to vendors or investors to arrive at the net forecasted cash flow statement.
On the other hand, an indirect pro forma cash flow statement will be prepared based on the financial components of a pro forma balance sheet and income statement.
It calculates cash inflow and outflow from various sources:
- Operating activities: Movements in inventory, current assets, and liabilities.
- Financing activities: Shares purchase or sale, business loans, etc., and
- Investing activities: Capital asset movement, including buildings, equipment, land, and business acquisitions.
Uses of Pro Forma Financial Statements
One of the many uses of pro forma statements is business and financial planning. This is perhaps the most common reason for creating pro forma statements.
From an internal management perspective, pro forma statements help project a business’s future state.
FP&A analysts and finance professionals use pro forma statements to evaluate multiple scenarios and assumptions to identify the financial impacts on an organization’s financial position, profit, and cash flow.
Pro forma financial statements are also helpful in assessing the financial implications of capital expenditure projects and other major restructuring initiatives of the business or organization.
For example, a one-off large expenditure on machinery and equipment can skew the financial results during the period when the equipment is acquired.
A pro forma financial statement can treat this purchase as a one-off capital investment not included when estimating the profit margin.
Some companies prepare pro forma statements to demonstrate to potential investors how sustainable and profitable their operations will be in years to come.
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Creating Reliable Pro Forma Financial Statements
Assumptions form the bedrock of pro forma statements; hence, a reliable pro forma statement is a financial model prepared based on realistic and justifiable assumptions.
Finance professionals and business owners must consider all the likely scenarios affecting a company’s finances to develop accurate forecasts.
Extensive research and review of prior financial statements are necessary to arrive at the best assumptions. Unrealistic assumptions will lead to inaccurate and unreliable pro forma statements.
How Datarails Helps Prepare Pro Forma Financial Statements
Businesses and finance professionals are always on the lookout for efficient ways to carry out accurate business and financial planning.
Preparing realistic pro forma financial statements is essential to getting business planning right.
Datarails’ FP&A solution is a one-stop shop for planning and building pro forma financial statements.
With Datarails, you are empowered with real-time financial data and integrated fragmented workbooks across multiple data sources. This data allows you to make more realistic assumptions and evaluate data from a single source.
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.
Pro Forma Financial Statements: FAQs
Why do banks require pro forma financial statements?
The bank might request a pro forma loan application approval or a financing request because it gives them an idea of the borrower’s financial position going forward.
It helps them see if the business can meet its obligations under different scenarios.
Why can pro forma financial information be misleading?
Pro forma financial statements can be misleading when the assumptions on which they are based are unrealistic or when they exclude important costs or liabilities.
This can lead to unduly optimistic projections of revenue or profit, which could mislead stakeholders into feeling more comfortable about a company’s financial position or condition than they should.
What is not considered a pro forma financial statement?
Actual financial statements, such as historical balance sheets, income statements, or cash flow statements, do not belong in the pro forma category.
Pro forma statements are always future-based, while actual statements are about what has already happened. Similarly, pro forma statements are hypothetical, based on assumptions.
Actual statements, however, are based on actual data from real events.
What are the three pro forma financial statements?
There are three pro forma financial statements:
- Pro Forma Balance Sheet: A forecasted statement illustrating projected assets, liabilities, and equity.
- Pro Forma Income Statement: A predicted profit and loss statement with anticipated revenues, expenses, and profit.
- Pro Forma Cash Flow Statement: Cash inflows and outflows to be realized if certain assumptions are made.