Understanding Pro Forma Financial Statements: Components and Uses

Here’s a basic list of common small business startup costs that turned up with a quick search. If we want to extend this forecast further into the future, we simply focus on increasing our revenue-driving activities (as long as they’re working). When we have some idea of how we’re going to drive sales, we can look at how the transaction between the business and the customer occurs, which is a critical part of our revenue model. There are many different revenue drivers, but our chosen method for generating new business should be appropriate for the amount we charge customers. We don’t want to spend three months courting a new client to sell them a $20 product. Alternatively, we likely won’t sell a $100,000 service with a couple of Google ads – although it could be the first step.

• This figure is like the pot of gold at the end of the rainbow, showing you what’s left after covering the direct costs of your products or services.
• Understanding how to create and interpret these statements is vital for business owners, potential investors, and financial analysts.
• Pro forma financial statements report on the balance sheet structure, profitability, and cash flow changes that a large transaction may produce.
• Not all these things should be left off, but the decisions of what is left off should be well thought out and explained to potential investors, so they have a clear indication of what they are viewing.
• Often, the difference between a past balance sheet and a pro forma balance sheet is that the pro forma balance sheet reports additional periods, sometimes even interim figures.
• Pro forma income statements have limitations, and business owners need other financial tools to make fully informed decisions.

Pro forma balance sheets are forward-looking, frequently looking out five years. Cash flow statements are particularly important for financial planning as they provide insight into how the business will finance its operations, pay off debts, and manage capital expenditures. We used local population data and identified coffee pro-forma income statement consumption trends to project potential sales growth. By considering factors like the increase in remote workers seeking café spots and the popularity of seasonal beverages, we crafted a realistic revenue projection. Creating a variety of hypothetical scenarios can help gain insight into the potential financial impacts of different decisions, risks, and opportunities.

Pro Forma Financial Statements (with Templates and Examples)

When we know how many units we need to sell, we may get a clearer picture of what else we need to do. For instance, we may now better understand how many customers we need, the number of leads we need from marketing, and maybe even the marketing budget required to achieve these numbers. The unfortunate thing about forecasting revenue in this way is that it doesn’t tell us what the hell we need to do to achieve our desired 20% growth. It’s great that we have a timeline and a goal, but it kind of feels like we’re throwing darts in the dark. With our income statement in hand, we then have to decide at what point in the future we will establish a goal, or outcome, for our Pro Forma. My motivation for this post is to explain the differences between creating a pro forma for existing businesses versus new businesses.

GAAP vs. Pro Forma

Managers then project cash activity for the last four months of the year to assess cash needs. Assume that an e-commerce company generates 50% of sales in the last two months of the calendar year. The business should spend large amounts of cash in September and October for inventory purchases. Managers often consider how company finances will look at the end of the fiscal year.

• One of the most important uses of pro forma reports is related to decision-making and strategic planning efforts.
• She knows this will require a significant investment and wonders if the numbers add up in favor of her vision.
• The income statement is produced for a specific period (month, quarter, etc.), and the matching principle matches revenue earned with expenses incurred to grow revenue.
• Bench simplifies your small business accounting by combining intuitive software that automates the busywork with real, professional human support.

One of the key purposes of pro forma analysis is forecasting financial performance. This isn’t just about predicting how much money you’ll make; it’s about understanding how various factors like market trends, new product launches, or changes in pricing could impact your finances. By playing out different “what if” scenarios, you can prepare for the future with confidence, making strategic decisions that propel your business forward. The adjusted nature of pro forma statements allows management to exclude certain items that they consider non-recurring or extraordinary. Running a small business comes with plenty of uncertainties, especially when it comes to finances.

Frequently asked questions about small business pro forma statements

Stable businesses can generally estimate income tax expense as a percentage of income before taxes. Our intuitive software automates the busywork with powerful tools and features designed to help you simplify your financial management and make informed business decisions. This happens when the business plans to make some retrospective changes in the income statement. For this purpose, the line items need to be adjusted so that the changes are reflected from the past years. Cash outflows are detailed under categories like Preliminary Expenses, Direct Cash Spending, Increase in Receivables, Increase in Inventory, Purchase Long-Term Assets, and Principal Repayment.

They create pro forma statements combining their own historical financial information with that of the acquisition target. This enables them to better understand the combined entity’s future financial performance and potential synergetic effects. Pro forma financial statements report on the balance sheet structure, profitability, and cash flow changes that a large transaction may produce. These components come together to help you understand your business from both a finance and accounting perspective. While finance focuses on forward-looking projections, accounting relies on historical data—pro forma financial statements help bridge the gap between the two.

Understanding Pro Forma Financial Statements: Components and Uses

Companies that provide large dollar amounts of stock-based compensation will incur expenses that must be recorded on the income statement. Assume a new product launch will increase revenue by 15% in the next fiscal year. Pricing is based on high demand for the product, and if the cost of sales is controlled, the company’s profitability moves higher. Successful SMBs use financial tools to forecast business performance based on assumptions. Companies must now provide standard GAAP results alongside any pro forma figures and explain all adjustments made.

Pro forma statements don’t need to meet the strictest accounting standards, but must be clearly marked as “pro forma” and can’t be used for things like filing taxes. Using pro forma statements that aren’t marked as such to misrepresent your business to investors, the IRS, or financial institutions can be penalized by the Securities and Exchange Commission). Let us look at the various types of the pro forma income statement in business plan. We’re about to cover what a pro forma income statement is and how to create one for your business. If you plan to acquire another business, this is the right pro forma statement for you.

Due to higher sales, accounts receivable will increase, and cash inflows will increase as customer payments are processed. With higher cash inflows, decision-makers can avoid borrowing from a line of credit. An income statement is based on actual company data, and a pro forma income statement is based on assumptions. When businesses close the month-end books, each revenue and expense account is reconciled, and the account balance is posted to the income statement.

By projecting outcomes for different strategies, such as expanding operations or cutting costs, businesses can identify the most viable path forward. For example, a manufacturer might use projections to decide whether to invest in new equipment or outsource production, weighing cash flow implications. When preparing pro forma financial statements, stakeholders must recognize that overly optimistic assumptions can mislead decision-making, particularly in securing financing or attracting investors. The allure of potential profits should be balanced with a realistic assessment of market conditions. If you are considering acquiring another company or pivoting the direction your business is headed, you’ll want to understand how that will impact your income.

However, as the increased sales begin to kick in, the future looks promising, with a return to healthy cash flow levels and profitability. It is crucial to note that pro forma financial statements should be used in conjunction with GAAP-compliant financials to gain a comprehensive view of a company’s health and potential growth. A business can change variables in the financial statements and assess the impact. If customers pay at a slower rate than forecasted, what is the impact on cash flow?

This give your pro forma earnings and is the moment of truth, revealing whether your business is on track to make a profit or if adjustments are needed. It’s like the final score of a game, showing you where you stand after all the plays have been made. This figure is like the pot of gold at the end of the rainbow, showing you what’s left after covering the direct costs of your products or services. Companies that provide large dollar amounts of stock-based compensation will incur expenses that should be recorded on GAAP-based income statements. Investors, lenders, and other stakeholders generally rely on GAAP financial statements, which are produced using actual financial transactions. Management can assess the impact on revenues and expenses and decide which decision makes the most financial sense.

This statement specifically deals with how your company’s results will change if you receive an infusion of capital. You may want to create financial projections for different investment amounts to cover your bases. For starters, pro forma analysis helps you make educated guesses about your company’s future revenue, expenses, and overall financial health. It’s like looking into a crystal ball, except instead of vague predictions, you get detailed forecasts based on solid assumptions and data. Businesses can generate a pro forma cash flow statement on a retail location to compare lease payments and other costs with cash inflows from sales.

Knowing how the pro forma documents are compiled and what is left out is also critical when comparing different pro forma statements. Understanding this methodology and the decisions behind it will enable accurate comparisons and information to investors. Once you’ve created your pro forma income statements, and cast your eyes forward to the future of your business, you can start planning how you’ll spend your money. While they all fall into the same categories—income statement, balance sheet, and cash flow statement—they differ based on the purpose of the financial forecast. It also enables companies to compare multiple future scenarios; yes, it acts as a strategic planning and risk analysis tool.

Pro forma earnings projections

They use pro forma financial statements to analyze different restructuring scenarios, such as cost reduction initiatives, refinancing options, or divestitures. This assists them in evaluating the long-term viability and profitability of their restructuring plan. Pro forma financial statements are used by business owners and companies for various strategic purposes.