If you own a business or manage the finances of an organization, you would often think of different possible outcomes for revenue, capital costs, investments, or profits based on certain 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.
In reality, no one knows exactly how much revenue will be made or how much expenses will be incurred at the end of a given period; however, a realistic forecast can be determined. This forecast forms the foundation of pro forma financial statements.
What are Pro forma Financial Statements?
Simply put, pro forma financial statements are financial reports that are created on hypothetical assumptions. For example, in creating a pro forma income statement, you would need to forecast revenue for future periods. This can be done by analyzing past sales, orders for products or services in the current period or any backlog orders yet to be fulfilled. A realistic revenue amount can then be forecasted and used in a pro forma income statement.
Pro forma statements are useful 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.
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.
Pro forma balance sheet
A pro forma balance sheet typically has all the components of an actual balance sheet, the major difference is that some or all of the financial reports have been forecasted based on expected events. For this reason, some people interchange the terms ‘pro forma balance sheet’ and ‘balance sheet forecast’. A pro forma balance sheet will show the forecasted assets, liabilities, and equity position of a business or organization at any period in view.
Pro forma Income Statement
The process of forecasting revenue, expenses, and profit is very important in financial planning and management. This is where a pro forma income statement comes in handy. A pro forma income statement will show how much a business or company expects to make in sales and revenue, it also highlights forecasted fixed or variable operating expenses and ultimately, shows how much profits and retained earnings can be made at the end of a future financial period.
Pro forma cash flow statement
Cash flow is king and knowing that 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 use either the direct or indirect method of cash flow reporting to create a pro forma cash flow statement.
A direct method of preparing a pro forma cash flow statement will entail 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.
An indirect pro forma cash flow statement, on the other hand, will be prepared based on the financial components of a pro forma balance sheet and income statement to calculate cash inflow and outflow from:
● operating activities such as movements in inventory, current assets, and liabilities,
● financing activities such as shares purchase or sale, business loans, etc., and
● investing activities such as movements in capital assets including building, equipment, land, business acquisitions, etc.
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 with projecting the future state of a business. 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.
Asides from assessing the financial results of day-to-day operations, pro forma financial statements can also be used to evaluate the financial impact of key capital investments and major restructuring projects on the overall business or organization. For example, a one-off significant expenditure for heavy machinery can throw off the financial results in the period that it is acquired. A pro forma financial statement can exclude the financial impact of this purchase to show what the profit margin will be without the one-off capital investment.
Additionally, some businesses use pro forma statements to show investors how profitable and viable their operations will be in future years. Pro forma statements are useful tools for forecasting and they show the projected growth in financial numbers over given periods.
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 on the back of realistic and justifiable assumptions. Finance professionals and business owners need to consider all the likely scenarios that affect the finances of a company in order to come up with accurate financial forecasts. Carry out extensive research and review prior financial statements in order to arrive at the best assumptions. Unrealistic assumptions will lead to inaccurate and unreliable pro forma statements.
How Data Rails Helps in Preparing 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 key to getting business planning right.
Datarails’ FP&A solution is a one-stop solution for effective planning and building pro forma financial statements. As an enhanced data management tool, Datarails allows you to use real-time data and integrated fragmented workbooks across multiple data sources to analyze realistic assumptions and evaluate data from one centralized location. This ultimately provides you with the resources to compare forecasts, budgets, and business plans and prepare accurate pro forma financial statements that are realistic for business planning.