How to Create a Pro Forma Income Statement

Pro forma financial statements are essential tools for businesses to plan and project their future financial performance. These statements are based on assumptions and estimates, helping companies understand the impact of various scenarios on their financial position. The three primary components of pro forma financial statements are the Pro Forma Income Statement, Pro Forma Balance Sheet, and Pro Forma Cash Flow Statement. Traditionally, financial analysis is used to better understand a company’s performance over a specified period. While this provides insight into a company’s historical health, creating pro forma financial statements focuses on its future, forecasted results. For this reason, these reports can be leveraged in several ways, including analyzing risk, projecting investments, and showing expected results before the end of a reporting period.

• Cash flow projections are another critical element, detailing the expected inflows and outflows of cash over a specific period.
• Rho is a business banking platform that offers everything companies need to manage their cash and grow their businesses.
• Pro forma income statements are not used to report actual financial performance.
• The legal liability of the company may increase upon submitting forecasts instead of pro forma income statements, but the practice may be more relevant for certain businesses.
• A pro forma income statement helps an owner with financial modeling on the cash flow statement.

As explained above, the pro forma statements may exclude one-time transactions from the analysis, so that stakeholders can review the impact. When it comes to accounting, pro forma statements are financial reports for your business based on hypothetical scenarios. They’re a way for you to test out situations you think may happen in the future to help you make business decisions. Whether you’re applying for an SBA loan or looking to bring investors on, the individuals you want to work with want reassurance that your business is a good investment. Looking back at historical financial statements is helpful, but if you’re planning big changes, the past may not be an accurate portrayal of what the future holds. It also highlights anticipated fixed or variable operational expenses and, in the end, displays the potential profits and retained earnings for a future financial quarter.

Calculate pro forma net income before interest and taxes

However, in its pro forma statements, the company might exclude this expense, arguing it’s a one-time event that doesn’t reflect ongoing business performance. GAAP requires companies to include all costs of doing business, even one-time expenses that may not recur. In pro forma statements, meanwhile, companies typically leave out certain items they consider “nonrecurring” or “extraordinary.” Expense projections in a Pro Forma Income Statement are inherently variable, reflecting the unpredictable nature of business expenses. Companies often categorize expenses into fixed and variable costs to better manage their financial forecasting. Pro forma statements are used by businesses to make decisions on planning and control, as well as for external reporting to owners, investors, and creditors.

• Managers can perform “what-if” analysis using pro forma financial statements and evaluate risks.
• Furthermore, pro forma statements might not take into account the full range of worst-case scenarios, increasing the risk inherent in making decisions based on these projections.
• These are Regulation S-X Article 11, and Regulation S-X 8-05 for smaller companies from 17 CFR 210.
• This exclusion helps stakeholders focus on the core business activities and their potential future impact.

Understanding pro forma financial statements is essential for anyone involved in financial planning or investment analysis. They provide insights that go beyond traditional historical financial reports, enabling more dynamic and responsive decision-making. If the income statement was about the flow of the game, the balance sheet is the snapshot at halftime. It shows everything your company owns (assets) and owes (liabilities), plus equity, at a specific point in time.

Example pro forma balance sheet

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For instance, an increase in assets might indicate successful investment in new technologies or facilities, while a rise in liabilities could signal the need for additional financing. Traditional profit and loss statements are based on actual financial results, providing an accurate representation of a company’s past performance. Pro forma statements, on the other hand, are based on hypothetical scenarios, such as the impact of a specific business decision or a future event.

How to create pro forma statements

This method is what most investors will want to see if you plan on raising money. What we need to do is focus on the activities you’re doing that drive revenue. New businesses are the perfect candidate for using what is known as a bottom-up forecast (in contrast to top-down). To develop a more “realistic” forecast, we’ll want to identify which line items on our pro forma are fixed versus variable, then forecast them appropriately. A savvier way to handle costs is to consider the differences between fixed and variable costs.

Preparing a Pro Forma Cash Flow Statement

Halfway through the season, it was clear we had “overwatered” their operations. We had to quickly adjust our “gardening strategy,” securing a short-term loan to cover the gap. It was a lesson in the importance of balancing our financial ecosystem carefully. You wouldn’t just hop in the car and drive off without mapping your route, would you? This is where pro forma analysis comes into play; it’s like the GPS for your business, guiding you through the financial landscapes of the future.

The company’s 35% gross margin assumption may be too optimistic, or the tax rate assumed in the analysis is much lower than the actual tax rate. GAAP requires businesses to conform to the matching principle and record revenue when earned and expenses when incurred to produce income. A pro forma statement may not follow the matching principle and post revenue and expenses based on cash flow changes. If your company must produce an introductory paragraph with its pro forma documents, it should describe the content of your pro forma documents. This means that it should define the transaction, the entities involved, and the periods of time.

While pro forma financial statements offer valuable insights into future financial performance, they differ significantly from Generally Accepted Accounting Principles (GAAP) statements. GAAP statements are standardized and regulated, providing a consistent framework for reporting historical financial data. In contrast, pro forma statements are more flexible and forward-looking, allowing companies to present hypothetical scenarios based on their strategic plans and assumptions. The pro forma income statement, also known as the projected income statement, outlines anticipated revenues, expenses, and profits over a specific period.

This adaptive approach not only enhances the accuracy of financial forecasting but also supports effective business planning. Including these components allows businesses to create a detailed view of their expected financial health, essential for effective financial forecasting and business planning. Yes, creating pro forma statements requires more work, but it pays off in showing you exactly what your future net income, liabilities, and cash on hand would be under certain circumstances. The Company may create pro forma statements considering an acquisition/merger of another business/Company. The Company will create financial statements for the past 2-3 years, considering the acquisition and its impact. This approach is useful for estimating the impact of an acquisition on the financials of the Company.

This provides stakeholders with a clearer understanding of the company’s financial position and helps them make informed decisions. All in all, the process of preparing a pro forma balance sheet is much the same as preparing a normal balance sheet. The same holds true for the process of preparing income statements and cash flow statements.

This will provide clearer insights into how different types of accounting can impact your financial projections. Pro forma income statements are not used to report actual financial performance. The Securities and Exchange Commission (SEC) has specific disclosure requirements for businesses that issue securities to the public, including pro forma financial statements. A pro forma financial statement uses hypothetical data or assumptions about future values to project performance and financial position over a period that hasn’t yet occurred. Even public companies are not required to get their pro forma document audited by an independent auditor, according to the SEC. However, to comply with professional auditing standards, the documents can be audited at the request of the company or a third party.

Once the assumptions and pro-forma income statement adjustments are defined, the pro forma income statement can be created. This document will show projected revenues, costs, and net income for a specific future period. The statement should also include separate columns to show the difference between historical financial information and the expected pro forma income.