Therefore, it prepares a projected balance sheet, income statement, and statement of cash flows for each of the three financing options. These projected financial statements are referred to as pro forma financial statements. In a sense, pro forma financial statements allow management to A/B test different strategies without any real-world impact. One of the most important uses of pro forma reports is related to decision-making and strategic planning efforts.
The pro forma part of the balance sheet is a projection that looks ahead, assuming certain things will occur. Pro forma balance sheets are difficult to compile, but banks generally ask for them and they are important for showing your potential financial picture. They can show the projection of what money will be tied up in receivables, equipment, and inventory. Further, they can represent if your company could run out of money, and how much is necessary to keep it afloat.
If you are new to HBS Online, you will be required to set up an account before starting an application for the program of your choice. We expect to offer our courses in additional languages in the future but, at this time, HBS Online can only be provided in English. Pro forma results may contain adjustments to GAAP numbers in order to highlight important aspects of the company’s operating performance. A budget anticipates the inflow of projected revenues and the outflow of funds for a defined future period, usually a fiscal year.
Pro Forma Earnings Projections
For some companies, pro-forma earnings provide a much more accurate view of their financial performance and outlook because of the nature of their businesses. Companies in certain industries tend to utilize pro-forma reporting more than others, as the impetus to report pro-forma numbers is usually a result of industry characteristics. For example, some cable and telephone companies almost never are food and meals taxable in michigan make a net operating profit because they are constantly writing down big depreciation costs. For example, net income doesn’t tell the whole story when a company has one-time charges that are irrelevant to future profitability. Your business might benefit by following the SEC guidelines for public companies outlining how to use pro forma statements, even if you’re not a publicly traded business.
- Lenders want to feel comfortable that a business has sufficient working capital and liquidity to support its operations.
- All in all, the process of preparing a pro forma balance sheet is much the same as preparing a normal balance sheet.
- It is not a true invoice because it is not used to record accounts receivable for the seller and accounts payable for the buyer.
- If the cash flow shows a positive figure, you can plan how to spend the surplus.
Pro forma financial statements are established on what-ifs rather than actual financial results. Small business owners draft pro forma financial statements to quantify the impact of potential business decisions, such as taking out a loan to grow your business. Pro forma financial statements give you and your team something to consider before signing on the dotted line. Before acquiring another business, investing in new equipment, or taking on new debt, businesses draft forward-looking pro forma financial statements to understand the effect. Unlike traditional financial statements that explain the past, pro forma documents usually look forward and rely on financial modeling and speculation. Pro-forma earnings describe a financial statement that has hypothetical amounts, or estimates, built into the data to give a “picture” of a company’s profits if certain nonrecurring items were excluded.
For example, GAAP requires deductions for such expenses as depreciation, amortization, restructuring expenses, one-time costs, stock payouts and employee stock options. Management might not feel that some of these expenses affect cash flow or are not part of normal operating costs, however. After this, use your costs and revenue projections to find out what your future net income might be.
Problems with Pro Forma Financial Statements
We put the “pro forma” label on these financial documents because there’s a lot of “what if” involved in their making. We should stress that pro-forma earnings are designed to give investors a clearer view of a company’s operations and, by their nature, exclude unique expenses and charges. Because traders and brokers focus so closely on whether or not a company beats or meets analyst expectations, the headlines that follow earnings announcements can mean everything. Such companies, however, are expecting people to forget that these expenses are real and need to be included. Pro forma statements can also play a major role in getting your business financed.
Why create pro forma financial statements?
Line items like income tax expense, on the other hand, typically don’t change directly with sales. Stable businesses can generally estimate income tax expense as a percentage of income before taxes. To get sign-off from key stakeholders, win investors, and strategically plan, you need to demonstrate that your ideas make financial sense. A pro forma invoice is a preliminary bill of sale sent to a buyer in advance of a shipment or delivery of goods. The invoice will typically describe the purchased items and other important information, such as the shipping weight and transport charges.
It’s a tool that business owners, decision-makers, stakeholders, investors, creditors, and others use to examine hypothetical conditions. They can look forward or backward, revealing insights that standard financial statements simply cannot provide. Examples of such costs are accounts payable, wages paid, credit payments, mortgage payments, etc. Returning to the example of the proforma balance sheet, such financial statements should include the amount that the start-up should pay for the month for example the cost paid to consultants, marketing agents, team members, workers, etc. After the values of all these liabilities have been recorded, they must be added together to calculate the final value of the total liabilities. Considering the best and worst scenarios, pro forma financial statements will help you make face challenges in the future.
Can You Compare Pro Forma Statements From Different Companies?
Since pro forma financial statements and financial projections are quite similar, they may be considered synonymous. However, financial projections can be built from nothing for a startup company, using specific industry-specific assumptions. By contrast, pro forma financial statements are based on current financial statements and change based on events and assumptions. In other words, pro forma financial statements start from real financial data.
Pro Forma Financial Statements Vs. Budget
Still, pro forma financials are not regulated to the same extent as historical financial statements. Pro forma financials offer businesses ways to make realistic assumptions about future growth rates and costs. According to Johnson, this is useful when you’re seeking outside capital (either debt or equity) to grow. “Potential capital suppliers will carefully examine pro forma financial statements (and the critical assumptions used in creating them) before committing capital to the firm,” Johnson said. 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.
What are Pro Forma Financial Statements?
When building pro forma financial statements, be sure to use realistic, conservative figures. The statement of cash flow indicates the amount of money that goes in and out of a business. A pro forma statement of cash flow can be helpful in determining when there might be a shortage of cash, which could help determine whether cutting expenditures or taking on a loan could help. These questions can be answered with the preparation of pro forma financial statements. However, management could prepare a set of pro forma statements to remove these extraordinary items and show the results of the company’s normal business operations. Pro forma financial statements are valuable tools managers can use to plan for the future, anticipate and control risks and acquire funding for their business.
Many Nasdaq-listed companies utilized pro-forma earnings management to report more robust pro-forma numbers. Taken cumulatively, the difference between GAAP earnings and pro-forma earnings for the dotcom sector during its heyday exceeded billions of dollars. Here are some ways pro forma financials can benefit your company, no matter which stage of operation you’re at. The U.S. Customs and Border Protection, for example, uses pro forma invoices to assess duty and examine goods, but the importer on record is required to post a bond and produce a commercial invoice within 120 days from the date of entry.