What is Pro-Forma Financial Statements

A pro-forma financial statement is a type of forecast that can be helpful in making financial predictions.

Jason runs a successful hardware store. For a few months, he has been thinking about expanding his business. By looking at his past financial statements, he can see that his company has enjoyed steady growth. However, Jason wants to attract investors. He knows that potential investors will want to see proof that the business can grow even further, and that its future is positive. In order to make projections about future performance, Jason puts together a pro-forma financial statement. The pro-forma financial statement makes assumptions about Jason’s business – about how it will perform over the next year. Jason gives the pro-forma financial statement to the potential investors, showing how his business is predicted to grow over the next twelve months based on current data. The investors are impressed, and they agree to help expand Jason’s hardware company.

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A company’s success often depends on how well a business owner can understand numbers, or finance. Understanding the role of numbers in running a business is crucial. Getting the approval of shareholders and attracting investors depends on an owner’s ability to express his or her ideas in a way that makes financial sense.

When it comes to understanding a business’ numbers, some financial statements provide a view of the company’s past performance. These financial statements include documents such as balance sheets, income statements, annual reports, and cash flow statements. While these kind of documents can help business owners understand their past financial performance, they do not necessarily provide a good assessment of where the company is going. Essentially, when a business owner is planning for the future, these numbers do not provide foresight, or the ability to see ahead.

When it comes to planning for the future, professionals like to look at forecasts and financial projections. This manner of report allows them to create appropriate plans and answer “what if” questions. A pro-forma financial statement is a type of forecast that can be helpful in making financial predictions.

What Is a Pro-Forma Statement?

A pro-forma financial statement uses hypothetical information or predictions about future values to project a company’s performance in a future period of time. This type of statement may also be referred to as a financial forecast or financial projection. The projections provided by the statement show what the business’ financial statements would look like if the assumptions made actually happen as predicted.

The phrase “pro-forma” refers to forecasts or projections, so it can be used to describe different types of financial statements. These might include:

  • Income statements
  • Balance sheets
  • Cash flow statements

Pro-forma financial statements can be very helpful for companies in that their projections can be used to help make business decisions. When a business owner, investor, creditor, or other decision-maker weighs the pros and cons of a major decision, they often use pro-forma financial statements to guide them.

How are Pro-Forma Statements Used?

Financial statement analysis is generally used to assess and understand a company’s financial performance over a certain period of time. This type of statement explores a company’s financial health on a historical basis by only looking at the past. A pro-forma financial statement, by contrast, focuses on future performance. These reports can analyze different aspects of future performance. These aspects include assessing risk, projecting investments, and predicting expected results before a reporting period ends.

One of the main purposes of a pro-forma report is to aid decision-making and assist in strategic planning. For example, let’s say a company has three investment opportunities to consider. How does the business owner assess them and know which one to pick? He or she can create a pro-forma financial statement to reflect the predicted outcomes of each investment scenario. This side-by-side comparison can help show which option is best for the business. The business owner can thereby plan accordingly and develop a strategy going forward.

How Does One Create a Pro-Forma Statement?

Creating a pro-forma financial statement is actually not that different than putting together a traditional financial statement. The primary difference between the two is the assumptions made about inputs. The format and calculations, however, stay the same.

That said, when a company puts together a forecast, it uses certain methods to make predictions. If a business uses the percent of a sales forecasting method, then the company must figure out future expected sales and find patterns across accounts.

Some line items can be easily predicted, such as the cost of sold goods. It can be assumed that the cost of goods will grow in proportion with sales. Some line items, such as income tax expense, do not correlate with sales. However, businesses can predict that income tax will be a percentage of income before taxes.

The Significance of Pro-Forma Statements

Pro-forma statements do not just contain numbers. They are important reports that can guide the decision-making process of shareholders, investors, and creditors. They can, in fact, affect the way a company does business and help determine whether it succeeds or fails. Managers and owners can benefit from creating pro-forma statements, because they will be able to see how different factors affect their business.

However, it should be remembered that pro-forma statements are just projections. While they can offer insight, they should not be taken as fact.

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