What does Pro Forma Statements mean in business?
Why are pro forma financial statements important in business?
Business investors generally want pro forma statements for forecasts and projections of a company’s profitability. A pro forma financial statement in simple terms means hypothetical financial projections. There are several types of pro forma statements examples which includes pro forma income.
Knowing Your Business Numbers
Business decisions are based on numbers, correct? For you and your business to deal responsibly and successfully with important stakeholders, win over investors, and make strategic plans for the future, it is essential for your key ideas to be financially viable. As a business owner, you need to be not only confident in your ideas but also be able to make others believe in them, too.
It is true that specific financial statements, for example, balance sheets or income statements, can help to provide a detailed view of a company’s performance. The same is true for other familiar documents, such as cash flow statements or statements of income.
Forecasting the Numbers
However, there is a limit to the depth of information that these general statements provide. For example, many times, they are unable to illustrate a sense of foresight and planning for future endeavors. When this sort of information is lacking, business professionals generally look to forecasts and various projections in order to guide them.
We are all familiar with asking “what if?” when attempting to ascertain where our company is headed vs. where we think it should be headed. These types of questions also usually involve us wondering what the future will hold in terms of events we cannot plan for, events that can either help or hurt our companies’ futures.
Hypothetical questions can be useful, and in today’s world, companies should be ready for every type of adversity. Yet, there are financial reports that can prove useful in doing some business forecasting, and these come in the form of what are known as pro forma statements. These financial reports are commonly used to anticipate future business scenarios and plan future moves. Read on for a deeper look at just what these statements are, where they are derived from, and why they have become such a prized piece of the decision-making process for business owners.
What is a Pro Forma Financial Statement?
A pro forma financial report leverages hypothetical data or assumptions regarding future values to performances overtime periods that have not occurred yet. In other words, these financial statements help to forecast hypothetical business performance that may occur in the future. Some think of these financial statements as “financial forecasts.” Others consider them “financial projections.” However, you decide to regard them, understanding how to use pro forma financial reports can be quite advantageous for your company.
You may be wondering about the terms “pro forma” and what it refers to. These two words have to do with forecasts, predictions, and projections. As a phrase, “pro forma” applies to a wide range of financial reports, including statements of income, balance sheets, and cash flow documents.
Using Pro Forma Reports
You also might be wondering how these types of reports can be used. In a general sense, these projections are able to depict how the financial statements of a business will continue to look for a specific period of time—if your judgments when preparing the statements hold true. So, if used correctly, these reports can help you predict your business performance in the coming years. Some refer to this as your company’s “financial or economic potential.”
Attempting to understand pro forma reports can require some experience. It can be difficult to sit down, interpret these financial statements, and extract some sense of future business performance. However, as we go over how these statements can be used, you will understand how so many creditors, business owners, and even investors utilize these pro forma financial reports in order to measure the possible impact of their decisions.
How Are Pro Forma Economic Statements Employed?
Usually, businesses analyze their financial statements in order to truly comprehend their company’s performance over a specific time period. This type of statement analysis can be useful in giving insight into the business’ economic track record. However, pro forma statements focus on a company’s financial future. In that manner, these reports can be influential and helpful in terms of risk analysis, projection of future investments, and displaying expected outcomes before the reporting period ends. So, while traditional statement analysis is still a smart idea, pro forma finance analysis can work together with more traditional analysis and provide a complete look at not only your company’s current performance but future goals and projections as well.
Example of Pro Forma Income
For example, a business owner might use pro forma statements to illustrate the projected conclusions of three different investment scenarios. This would produce a beneficial side-by-side comparison featuring different outcomes. Then, it would be easier to figure out which outcome is the best and plan around that goal for the future. Therefore, pro forma statements relate directly to informed business decisions and skillful strategy. Using these statements correctly can only enhance and sharpen your vision for your company.
Preparing Pro Forma Statements
It is important to note that the usual process of forming these financial statements is not much different than what you are used to. The main contrast between pro forma reports and more traditional statements rests in the assumptions, as well as modifications made to various inputs. However, the calculations and overall formatting stay mostly the same.
If you have heard there are specific processes used for pro forma reports, you are correct. For example, the percent of sales method of forecasting requires both determining expected sales in the future and identifying trends in your accounting statements. This technique is used when forming internal pro formas.
There are additional line items that can easily be individually forecasted, for example, costs of goods that have been sold. This is because an assumption can be made: that the cost of the goods being sold will grow in correlation with sales. Alternately, items such as income tax expenses will not change with sales. Businesses that are generally stable are able to estimate expenses related to income taxes in terms of it being a certain percentage of the company’s income pre-taxes.
Overall, when you prepare your pro forma statements, you will realize it is similar to creating a regular balance sheet for your company. This is also true for prepping income statements, as well as statements regarding cash flow.
However, it is important to note that when your business starts to forecast numerous line items and begins to calculate how these projections will impact your business’s bottom line, the process will differ.
A Value That Cannot Be Counted
The intrinsic value related to pro forma reports far surpasses the numbers they produce. For business owners, these financial statements, if used correctly, prove extremely important. Also, pro forma reports can equip creditors, important stakeholders, and investors with the numerical foresight and vision they need to make strategic decisions and draft plans. Additionally, managers, as well as individual contributors, can benefit from the creation of a pro forma statement. This type of report can enable them to more clearly understand the various factors that impact their business units and how their business may run in the future.
As much as we want to emphasize how useful pro forma statements can be for your business, this comes with a word of slight caution. Because these documents are derived from assumptions, they should not be interpreted as facts. Instead, the documents and numbers therein can help to inform decisions based on the relevant hypothetical and historical data.
Guidance Will Help You Raise Your Numbers
There are financial accounting courses individuals can take online in order to find out more about what a pro forma statement can do for you. Also, our business lawyers & corporate attorneys at Nakase Wade offer free consultations in case you have additional questions. If you can achieve mastery over pro forma reports, you will be able to further grasp the specific language found in the world of accounting and also how to create and interpret forecasts in order to make confident calculated decisions. After all, a successful business runs on strategic decision making, as well confidence and insight. If you possess these qualities, you are well on your way.
Douglas Wade, Attorney