What are Pro Forma Financial Statements?

There are loads of financial statements to familiarize yourself with when it comes to small business accounting.

Unlike well-known financial statements like the balance sheet and cash flow statement, pro forma statements are entirely different. 

Pro forma financial statements are special types of reports that companies draft and distribute to inform others about future projections. Some common statements include: 

• Pro forma income statement
• Pro forma balance sheet 
• Pro forma cash flow statement

Each of these statements has a different purpose and general statement structure. In this article, we will go over each of the pro forma financial statements and tell you all you need to know about them. If you’re interested in learning more, then keep on reading!

What is a Pro Forma Financial Statement?

Pro forma financial statements sound complicated, but with a thorough explanation, you will soon gain a solid understanding of these reports. 

Pro forma financial statements are reports created by companies with the purpose of distributing them to specific parties. Their main purpose is to share information about future projections, using assumptions and hypothetical situations. These statements also present assumptions based on financial calculations. 

Pro Forma Income Statement

There is not one universal pro forma financial statement, as businesses alter various financial statements to explore various scenarios. To keep things simple, we will start with the widely-used pro forma income statement. 

What Is a Pro Forma Income Statement?

The pro forma income statement is a report that shows how a business’s income would change if certain expenses were no longer a factor. 

For example, if your business is struggling because of a failed product, it may seem like the business is dying. However, with a pro forma income statement, management can show investors that, without the debt and other losses from the failed product, the business’s finances would look much better. 

The pro forma income statement is nothing more than a mockup of a hypothetical situation where some financial factor is removed. Showing this statement to investors could make them look at a business with a bit more optimism. 

Pro forma statements are often used to secure funding from investors or to convince a corporation to lend funds to the business. 

How to Create a Pro Forma Income Statement

There are two types of pro forma income statements: projection and historical profit & loss. The historical profit & loss statement will look at the past financials, and the projection statement will attempt to simulate the future. 

You can create a historical profit & loss pro forma income statement by starting with your true income statement spreadsheet. Add one column to each of the quarters in question to list all of the costs that you would like to remove. Add another column to show the totals after the costs have been subtracted (the second column holds the pro forma values). 

To create a report that shows projections, you will compile all of the projections from each business area. The final report will act as a cohesive forecast for the business. 

Pro Forma Balance Sheet

A pro forma balance sheet is a bit different from a pro forma income statement because of the figures that are included on each of the statements. The pro forma balance sheet will show a projected version of the company’s actual balance sheet, like: 

• Assets like money, property, and inventory. 
• Liabilities, which encompass any debts owed or any outstanding obligations. 
• Equity, which is the result of subtracting total liabilities from the company’s assets. 

The pro forma balance sheet would model for specific parties various scenarios that change the company’s assets, liabilities, and the total equity. 

The principles behind the pro forma balance sheet are similar to those of the pro forma income sheet. They are modified to help with forecasting or evaluating the historic profit & loss. 

Pro Forma Cash Flow Statement

Another one of the most common pro forma financial statements is the pro forma cash flow statement, which will examine just how much money will come into or leave the business in the future. 

A traditional cash flow statement looks at the following financial aspects: 

• Cash coming from business activities. 
• Cash coming in from investment activities. 
• Cash from financing. 

Pro forma cash flow statements are manipulated, just like the others, to see how certain actions would affect the numbers. 

Reasons to Use Pro Forma Financial Statements

There are several situations in which creating a pro forma financial statement may be helpful. The following section will look at some reasons why you might use this type of statement. 

Pro forma financial statements are a great resource for predicting a company’s financial position after a certain change is made.  A business may also benefit from using this statement if they are considering an acquisition. 

• During interviews. When hiring someone for a high-level position within your company, you may need to convince them that the future of the company is bright. 
• Simulate financials for internal parties. Pro forma statements are not always for those outside of the company. Using the statement for this purpose can potentially save the company from a bad financial decision. 
• Provide income projections to lenders or investors. The statement may be helpful to them in helping them decide whether to invest in the company. 

Limitations of Pro Forma Financial Statements

Some lenders and creditors may hesitate to consider pro forma financial statements, and this is because the information on the statements cannot be taken as fact. 

Often, business owners and staff may be overly optimistic with their projections, leading to inflated revenues, cash flows, and profit. No one can trust a pro forma financial statement with 100% certainty because no one knows what the future holds for a business. 

Executives and staff members at some companies purposely inflate their predictions on these statements, which usually does not bode well for the company. 

Be Careful with Pro Forma Financial Statements

If you are thinking about using pro forma financial statements to guide your own internal decisions, we urge that you do so with caution. We touched on how pro forma financial statements are not very accurate. In fact, they are more likely to be wrong than right.

So, if you decide that you want to do some forecasting via a pro forma financial statement before making a big decision, make sure that the statement is based on reliable sources. Do some research on trends that exist in your market. Consult experts in your field to get their input. Consider conducting a poll to gauge buyer attitudes and preferences. 

Do your due diligence to increase the chances that your predictions will be accurate. However, don’t forget that, no matter what you do, you will still run into issues of accuracy and reliability when using pro forma financial statements. 

Ask a Professional

It is recommended to allow a professional to create your pro forma financial statements, being that they require advanced accounting knowledge. Perhaps, the best person to do your pro forma statements is an internal accountant. This person will have experience drafting these types of reports, and they also have a general idea of the inner-workings of the company. 

They may also be able to make predictions that are backed by historical data. This way, you won’t have to worry about outlandish predictions. 

Final Thoughts

Not only do you know what pro forma financial statements are, but you also know about all of the major types of pro forma statements and how they work. We hope that this article will be helpful as you seek out information about pro forma financial statements.