Pro forma financial statements: What to include + how to create

But generally, these are the steps you need to take to create them—and the info your pro forma statements should include. Always compare pro forma numbers with standard GAAP financial statements, which must follow strict accounting rules. Misleading or overly positive pro forma financial projections are considered a form of fraud by the SEC.

• You’d consider the rain forecast (seasonal trends), whether you’re planting more thirsty plants (new products), and how well your soil retains moisture (cash on hand).
• Using tools like forecasting and scenario planning, decision-makers can estimate the organization’s future financial position and determine actionable strategies to optimize performance.
• Depreciation and amortization are also operating expenses but are often separately listed in the income statement.
• The balance sheet projections are equally important, encompassing assets, liabilities, and equity.
• Big corporations who have in-house accountants use pro forma statements for financial modeling and forecasting different scenarios.

Management can assess the impact on revenues and expenses and decide which decision makes the most financial sense. Cost of goods sold (COGS) includes costs directly related to producing the product or service. Standard computes the three-year average for the income statement balances listed below.

Pro formas can help a company and its lenders determine the most appropriate type of financing. If you’re ready to try this process independently, you’ll generally need to use spreadsheet software like Microsoft Excel to put the pro forma together. If you’re not familiar with spreadsheets, then it will be another learning curve to overcome. To illustrate why this distinction matters, let’s imagine you and I start a business, and in the beginning, we expect sales to be relatively low; say one hundred units.

Big corporations who have in-house accountants use pro forma statements for financial modeling and forecasting different scenarios. While this might give a clearer picture of regular operations, it could also make the company’s financial health appear better than it is. From here, too, it’s also pretty apparent how pro forma statements can be used to shift enough into supposed “one-time costs” so as to be misleading—which is against the law. 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.” VF Corporation began with its existing balance sheet, showing $11.5 billion in total assets.

• When creating a pro forma balance sheet, you might consider if any assets will be purchased, any investments will be sold or any debt will be paid.
• His knack for identifying opportunities and solving complex financial problems has earned him a reputation as a trusted finance expert.
• The Securities and Exchange Commission (SEC) has specific disclosure requirements for businesses that issue securities to the public, including pro forma financial statements.

What is the purpose of pro forma financial statements in assessing a company’s financial health?

These companies must prepare pro forma statements to show how significant transactions, like mergers or acquisitions, will affect their financial position. This transparency helps inform investors and regulators about the expected financial impact of the proposed transaction. Accordingly, the Company’s management can include or exclude line items that they feel may not accurately measure its estimates. An income statement is based on actual company data, and a pro forma income statement is based on assumptions. When businesses close the month-end books, each revenue and expense account is reconciled, and the account balance is posted to the income statement.

Projecting with Precision

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.

Variable vs. Fixed Costs

However, to comply with professional auditing standards, the documents can be audited at the request of the company or a third party. The SEC guides auditors to ensure that they do not take on too much responsibility for the company’s claims. While pro forma statements can be clarifying, investors need to understand their significant limitations. Like weather forecasts, they’re helpful for planning, but not guarantees of what will happen—especially if those projections use rosy financial assumptions. For instance, when Apple Inc. (AAPL) releases its quarterly earnings, it often includes pro forma projections for the next quarter, factoring in expected iPhone sales and potential supply chain costs.

Problems with Pro Forma Analysis

Pro forma financial statements are most useful when analyzing potential business decisions or anticipating the impact of future events. However, they should not be used as a substitute for traditional financial statements when assessing a company’s overall financial health or stability. Additionally, pro forma statements can be misleading if based on unrealistic or overly optimistic assumptions, and users need to scrutinize their underlying premises carefully. The adjusted nature of pro forma statements allows management to exclude certain items that they consider non-recurring or extraordinary. Projections that estimate a company’s future financial performance based on hypothetical scenarios.

Get the Plan, Partner, and Process to Confidently Grow Your Business

This helps in setting realistic goals and objectives based on anticipated changes. If a company had a one-time cost, it might not report such cost on a pro forma financial statement, considering it’s a one-time cost and, if included, does not show the Company’s operational performance. However, under GAAP, it will have to report the one-time cost and thus negatively impact the Company’s net income.

These costs can be rent, salaries, insurance, and other expenses that don’t fluctuate much with a given level of revenue. If we don’t expect to hire any new employees, it doesn’t pro forma income statement make sense to use a percentage of revenue to forecast salary costs. If we need to forecast our pro forma over multiple future periods, say on a month-by-month basis over the next few years, we use the exact same approach detailed above. Once we’ve converted all costs into a percentage of revenue, we simply multiply each one by the forecasted revenue to get our costs for the pro forma.

That’s because they might derive their numbers using very different economic and financial assumptions and techniques. The template calculates Net Cash Flow by subtracting Total Cash Outflow from Total Cash Inflow for each period, then updates the Cash Balance accordingly. This is essential for monitoring liquidity and ensuring the business can sustain operations without running into cash shortages.

To prepare a pro forma statement, you can use a financial statement template or pro forma sample spreadsheets, like these from Smartsheet. Keep in mind, expenses can be fixed or variable, and they are calculated as a percentage of sales. You can calculate a base percentage of sales by averaging sales over a certain time frame, and then use that percentage to estimate your projections. This would be helpful to lenders and partners who might otherwise be alarmed at such a negative performance.

Pro forma income statement: definition, purpose, and examples

Luckily, if you are creating a pro forma for a new business, you can try our software, Poindexter, for free! We’ve made it easy to create pro forma financials in a fraction of the time, and it won’t require any special knowledge. Now categorize each cost from our list into the appropriate section of the pro forma income statement. Now we’re done with the hard part, and all we have left is to add each cost to our pro forma income statement.