And while pro forma financial statements don’t quite provide a crystal ball level of omniscience, they sure do come in handy when it’s time to look at a what-if scenario or two. Russell creates a pro forma income statement for next year to inform his decision. Russell follows The Ascent’s guide to forecasted financial statements to generate the document.
For instance, what happens if your main vendor raises their prices like they did last year? Or how will that proposed transaction of buying new equipment impact you long term? Risk analysis lets you take the future for a test ride, and try out different outcomes. Do you want to learn more about what’s behind the numbers on financial statements?
- This is done by taking the difference between revenue, or sales and expenses, or the costs involved in doing business.
- According to the SEC, when required for public companies, pro forma income statements are required for the fiscal year, but not for interim periods.
- To prepare your pro forma income statement, you’ll need to determine your estimated revenue projections.
- Pro forma financial statements – balance sheets are formulated based on the outlining of the future financial position of the business after the proposed transaction occurs.
The Smartsheet platform makes it easy to plan, capture, manage, and report on work from anywhere, helping your team be more effective and get more done. Report on key metrics and get real-time visibility into work as it happens with roll-up reports, dashboards, and automated workflows built to keep your team connected and informed. Pro Forma Financial Statements are an insightful way to investigate fictitious scenarios, but it’s important to remember that they are based on forecasts, not facts.
Pro Forma Income Statement
For example, some cable and telephone companies almost never make a net operating profit because they are constantly writing down big depreciation costs. It’s helpful for FP&A to provide business leaders with side-by-side comparisons based on different assumptions, better informing the entire decision-making process. If, for instance, management is deciding between two separate proposals or business plans, they can use pro forma statements for each scenario and see which might serve their goals and vision best. According to Russell’s projections, he reaches the highest earnings when he hires a full-time administrative assistant. More significantly, the pro forma income statement reveals that hiring a part-time assistant is nearly as lucrative as bringing someone on full-time.
We’ll be in your inbox every morning Monday-Saturday with all the day’s top business news, inspiring stories, best advice and exclusive reporting from Entrepreneur. Statistics you can look at include how many people are within a few miles and what percentage meet your demographics. After calculating steps 1 and 2, you should be ready with the total asset value. The estimated total asset value is equal to the sum of the current and long-term asset values calculated in the previous two steps. Then estimate all of your costs and liabilities, such as loans, rent, payroll, taxes, etc. Say you’re a business owner contemplating a loan to invest in more efficient equipment.
And if the company uses debt to fund the project, there might also be a substantial loan balance on the liabilities side of the balance sheet. A pro forma cash flow statement could detail any payments involved in a hypothetical project. For example, the company might have to pay for land, materials, and fees to contractors who build the facility.
Some people have trouble differentiating the cash flow pro forma from the projected P&L. The concept “profit” is so pervasive that it poses a barrier to understanding that positive cash flow does not equal profit (or vice versa). The example of a profitable growing company with negative cash flow succumbing to illiquidity and tumbling into Chapter 11 bankruptcy is commonly cited to disprove the identity. Revenues are up, receivables are up, expenses are up, even profits are up. Yet the company runs out of cash, can’t pay its bills, and becomes another cash flow victim.
Does the EU’s CSRD apply to your business?
As an example, he explained that if the base case is that revenue grows by 20% over the next few years, one may want to lower that projected growth rate to, say, 10%, to see how the firm’s financials look. As a slight aside, for more in-depth insights on pro forma adjustments as well as some handy best practices and examples, we urge you to look at our Ultimate Guide to Pro Forma Statements. For these walk-throughs, however, we’re assuming you’ve already looked over the different events and scenarios that can prompt pro forma adjustments. I’d advise Russel to hire a part-time assistant to reduce the risk of sinking nearly $60,000 into a new position when he’s not sure he’ll see the increased revenue he’s expecting. He can always offer the person a full-time job after his projection actualizes.
Business plans and financing proposals are based on projections. Here’s how to set attainable financial goals.
They are built into the data to give a picture of a company’s profits if certain nonrecurring items are excluded. A pro forma income statement uses the pro forma calculation method, mainly to draw the attention of potential investors to specific numbers when a company issues its quarterly earnings announcement. If your company must produce an introductory paragraph with its pro forma documents, it should describe the a quick guide to breakeven analysis content of your pro forma documents. This means that it should define the transaction, the entities involved, and the periods of time. In this paragraph, you should offer a high-level explanation of the limitations and assumptions the pro forma documents were produced under. For example, if your company recently acquired or dispensed with another company, the assumptions would be the changes in finance expected.
Reasons to use pro forma financial statements
Let’s take a look at what pro-forma earnings are, when they are useful and how companies can use them to dupe investors. The best way to package a quote for your goods and services is by using a pro forma invoice, also called a draft invoice. In the Parliament of the United Kingdom, the equivalents are the Outlawries Bill in the House of Commons and the Select Vestries Bill in the House of Lords.
Intangibles like depreciation and goodwill are okay to write down occasionally, but if the company is doing it every quarter, the reasons for doing so might be less than honorable. The dotcom era of the late 90s saw some of the worst abusers of pro-forma earnings manipulations. 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.
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. For this reason, investors must examine not only the pro forma earnings, but also GAAP earnings, and never mistake one for the other. In this case, the company is projecting the future, based on its knowledge of past sales and expenses and factoring in expected changes.
Management might not feel that some of these expenses affect cash flow or are not part of normal operating costs, however. Furthermore, when management has to gauge the probability of success or failure and decide if a potential return is worth the risk, pro formas are a way to examine the effects of different outcomes. Since we used a sales-driven projection, other variables like operating expenses, depreciation & amortization, and interest expense were unaffected by our pro forma adjustments.
In trade transactions, a pro forma invoice is a document that states a commitment from the seller to sell goods to the buyer at specified prices and terms. It is not a true invoice because it is not used to record accounts receivable for the seller and accounts payable for the buyer. The term is used in legal and business fields to refer to various types of documents that are generated as a matter of course.
Many of the items listed above are part of the GAAP, but not included in pro forma reporting, making it rife for possible deception. This discrepancy is part of the reason the distinction between pro forma and GAAP financial statements is important. 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. 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. Compiled pro forma financial statements can form the basis for calculating financial ratios and financial models, which test assumptions and relationships of your company’s plan.