Pro Forma Income Statements Understanding Their Significance and Use

Pro forma statements of cash flow estimate how much cash inflow and outflow is expected in one or more future periods. Often requested by banks, they may also be prepared as a part of the annual budgeting or forecast and estimate where cash shortages may occur in order to obtain additional funding. In the case of estimated cash overages, the company can produce a plan for investment. Arguably, the statement of cash flow is the most important of the pro forma documents.

These projections are crucial for creating a realistic financial forecast. Including these components allows businesses to create a detailed view of their expected financial health, essential for effective financial forecasting and business planning. 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. When building pro forma financial statements, be sure to use realistic, conservative figures. In the business lending world, lenders will look at a company’s pro forma balance sheet to determine the debt-to-equity ratio for additional lending.

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Factors such as shifts in consumer behavior, inflation rates, and competitive dynamics are often not fully integrated into projections. Ignoring these elements can result in a disconnect between projected figures and actual performance. Management’s responsibility is to never get caught by surprise, anticipate changes and always be prepared for upcoming conditions. Pro forma financial statements are essential tools to meet those obligations.

Pro Forma Statements vs. Budget: What Is the Difference?

When creating a pro forma balance sheet, you might consider if any assets will be purchased, any investments will be sold or any debt will be paid. Investors and creditors often use pro forma statements to help understand the planned actions of management. Comparison of pro forma and actual financial statements can help them to appraise whether these planned actions are in their best interest.

For business and accounting, the use of pro forma first boomed in the United States in the late 1990s. These reports would place emphasis on estimated net revenues, cash flows and taxes. They are also often used in investment proposals to give an indication of the validity of the business to a potential investor. It is used to highlight certain specific figures that a company may want to draw potential investors’ attention to. When you’re running a business, it’s vital that you are able to keep a close eye on your financial statements.

Pro forma financial statements FAQ

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. Expense projections in a Pro Forma Income Statement are inherently variable, reflecting the unpredictable nature of business expenses.

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What are Pro Forma Financial Statements?

Pro forma financial statements come in various forms, each serving a unique purpose in your business planning. Pro forma income statements do not comply with Generally Accepted Accounting Principles (GAAP). Investors, lenders, and other stakeholders rely on GAAP financial statements. A business valuation analysis should clearly state if what is pro forma income pro forma financial statements are used.

Stock-based compensation expenses

• You can calculate a base percentage of sales by averaging sales over a certain time frame, and then use that percentage to estimate your projections.
• In the case of estimated cash overages, the company can produce a plan for investment.
• Pro forma documents, in any form, are essentially like letters of intent, expressing what an invoice or transaction is anticipated to look like after completion.
• For this projection, you need to determine where in your company the investments would be parlayed.
• It may be tempting to think of a pro forma statement as the same as a business budget.
• Businesses also create a pro forma balance sheet and a pro forma cash flow statement.

After the dot-com bubble burst, the SEC tightened rules to prevent misleading pro forma reporting—its first case after doing so, though, wasn’t against a tech company but Trump Hotels & Casino Resorts Inc. In simple words, Pro-Forma earning exclude non-recurring items like restructuring charges and extraordinary items. In this, the company’s earnings are not calculated according to Generally Accepted Accounting Principles (GAAP). However, ongoing litigation might be a regularly occurring cost in some businesses, such as medical devices, and should be reported as a normal cost of doing business. Prudent financial management requires a balance between the amount of debt a company owes compared to its equity base. For example, it would highlight what would happen if a company’s main vendor raises their prices.

Since pro forma statements deal with potential outcomes, they’re not considered GAAP compliant. This is because GAAP compliant reports must be based on historical information. VF Corporation began with its existing balance sheet, showing $11.5 billion in total assets. Companies often use pro forma statements to present their finances in the most favorable light. During the late 1990s dot-com boom, many internet companies used pro forma results to transform losses into apparent profits by excluding significant costs. For instance, a tech company might have shown pro forma profits by leaving out stock-based compensation expenses, even though these represent real costs to shareholders.

Use this Excel pro forma invoice template to create your own pro forma invoices. By presenting a compelling financial outlook, businesses can enhance their investor attractiveness and increase the likelihood of obtaining necessary funding. You can then determine the net effect on cash based on the hypothetical scenario.

• Pro forma financial statements, including cash flow statements, provide insights into a company’s anticipated cash inflows and outflows based on specific business scenarios.
• These things could vary from declining investment values and restructuring costs.
• Use the templates found here to create your own cash flow statement forecast.
• If your company has a high debt-to-equity ratio, it will show on the balance sheet.
• Regular income statements, sometimes called statement of financial performance, are exacting, in that they reflect the exact income figures your company had in past years.

If interim period balance sheets were submitted, the company should pick up from where they left off. If it is an annual period, the document should also align with the company’s filed GAAP-approved financial statements. Pro forma statements are useful with regard to tracking future financial direction and occurrences, often including some historical numbers to help account for what the projected outcomes should look like.

Since pro forma financial statements and financial projections are quite similar, they may be considered synonymous. However, financial projections can be built from nothing for a startup company, using specific industry-specific assumptions. By contrast, pro forma financial statements are based on current financial statements and change based on events and assumptions. In other words, pro forma financial statements start from real financial data. Unlike regular financial statements that follow generally applicable accounting principles (GAAP), companies have considerable flexibility in preparing these numbers.

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. To get sign-off from key stakeholders, win investors, and strategically plan, you need to demonstrate your ideas make financial sense.

Running a small business comes with plenty of uncertainties, especially when it comes to finances. You spend most of the time wondering how to plan for the future, but it’s tough to make informed decisions, secure funding, or plan for growth without a clear financial forecast. Pro forma income statements are not created using historical financial data. Information posted in the income statement may be excluded in a pro forma statement.