So your business is chugging right along, and you’ve had great financial results for years. You have no problem proving to a potential investor or lender that your company is doing well. But…you’ve got big things in the works. Maybe you’re selling off part of the company, or acquiring another. Now you need an accounting tool that will help you see how the numbers will change with this transition.
But generally accepted accounting principles (known as GAAP) only look at historical financial statements and don’t help you predict the future.
Short of having a crystal ball, pro forma financial statements can help you predict things like net income and gross profit in the future. Using these financial statements, you can plan for the future and lower your risk, as well as attract investors or get approved for financing.
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What are Pro Forma Financial Statements?
Pro forma financial statements essentially forecast the future. Standard accounting statements like the balance sheet look at historical financial information, but pro forma documents look forward to help you predict future income through different types of accounting statements. A business’ pro forma statement may include projected revenue, estimated expenses, and cash flow for three to five years.
Types of Pro Forma Statements
- Full-year pro forma projection
- Historical with acquisition pro forma projection
- Financing or investment pro forma projection
- Risk analysis pro forma projection
There’s no single pro forma income statement. In fact, there are several pro forma financial statements, and you may want to use more than one to get a full financial picture of your business.
Full-Year Pro Forma Projection
This pro forma projection includes a business’ year-to-date results as well as forecasted income and expenses for the rest of the year to provide a full year view. This pro forma projection is useful to investors and lenders, who want reassurance that your business is slated for profitability.
Historical with Acquisition Pro Forma Projection
If you plan to acquire another business, this is the right pro forma statement for you. It combines your business’ accounting results with that of the business you want to acquire, subtracting acquisition costs and synergies, and therefore shows a rough sketch of how the acquisition will blend into your balance sheet.
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Financing or Investment Pro Forma Projection
If you plan to seek funding from investors or take out a business loan, you may be asked for revenue projections. 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.
Risk Analysis Pro Forma Projection
Whenever making a major financial decision, you need to know best- and worst-case scenarios. That’s where pro forma risk analysis comes in handy. By creating pro forma reports for a variety of scenarios, you can see how a decision will have an impact on your bottom line and make your decisions accordingly.
Three Most Important Pro Forma Financial Statements
In addition to the pro forma financial statements listed above, there are others that you will find useful in your company, even if you’re not planning a major change like taking on investments or acquiring another company.
- Pro forma income statements
- Pro forma balance sheets
- Pro forma cash flow statements
Pro Forma Income Statements
Also known as a profit and loss statement, this accounting document shows sales transactions and expenses, as well as cost of goods or services sold and projected net income and profit.
Pro Forma Balance Sheets
The pro forma balance sheet looks at a forecast after a change, like financing or acquisition. It includes assets and liabilities, as well as accounts receivable, cash and cash equivalents, accounts payable, and inventories.
Pro Forma Cash Flow Statements
Another of the pro forma reports you should know about is the cash flow statement. It looks at the likely amount of cash flowing into and out of the business over a future period, based on different scenarios.
Why Create Pro Forma Statements?
So if you’re already using GAAP financial statements, why would you go to the trouble of creating pro forma financial information? There are several situations where having a pro forma income statement or other report can come in handy.
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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.
Lenders and investors want reasonable assurance that their investment will not only be paid back, but that they will see a positive return on it. Pro forma financial information can help them assess that likelihood.
Planning for the Future
While we can never know what the future holds, we can make some educated forecasts about what it might look like with pro forma income statements. Looking at a few scenarios ranging from worst case to best, you can see what the impact of these changes might be and use this information to guide your decisions.
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. Creating a pro forma cash flow statement can help you determine how quickly you will become liquid after this transaction, and you can also determine how many more liabilities it will create.
Nav’s Final Word: Pro Forma Financial Statements
Yes, creating pro forma financial 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.
Pro forma projections aren’t written in stone. Certainly, conditions will change, and that will impact your balance sheet. But these accounting tools can provide you (and your investors) peace of mind in knowing that a financial move is likely to pay off over time.