Suppose a company has recently gone through a substantial restructuring program. Stores or plants were closed; employees were laid off and benefits paid; departments were combined. After many years of research and development (R&D), they have applied for a patent on a new type of widget press technology. If they are granted the patent, they will be the only company that can use this new technology for 10 years. This new technology will allow XYZ Company to manufacture widget presses at half their current cost and several times more quickly. This could potentially make them the preferred provider in the space and help them gain market share.

  • 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.
  • Unfortunately, most organizations don’t have a fleet of battle-tested CPAs to fully leverage pro formas, especially startups and small businesses.
  • Most repeated users of pro forma statements are the investors or potential investors who want to know if their investment will pay off generously or not.
  • With the help of pro forma statements, he can have an idea or estimate about future performance.
  • Account for the recurring operational expenses for the company, taxes, and interest on loan payments.

The pro forma statements are most commonly used to draw the attention and focus of prospective investors. Besides forecasting and budgeting, companies use significant estimations and methods to quantify their future projections. Many business entities prepare Pro Forma statements to predict the impact of a recent economic event, growth opportunities, etc., with the help of hypothetical numbers. In developing assumptions, using historical data from your practice helps determine future expectations. The historical data should be augmented with benchmark data such as that provided by MGMA or other survey reports.

Forecasts made from these financial statements may or may not contain an even higher degree of deviation from the actual state of the company. Although pro forma statements have advantages, they have limitations and downsides. After all, the statements are projections, which are essentially guesses about the future. 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. The hypothetical scenarios in pro forma financials can help analysts predict risks early and prepare for them before making any concrete changes. This type of pro forma projection takes into account all of your financials for the fiscal year up until the present time, then adds projected outcomes for the remainder of the year.

These projections detail how much money the company will need to borrow and how the loan will be paid back. They have multiple uses for multiple scenarios, ranging from sales growth projections and risk analysis to more intricate M&A or investment purposes. Unfortunately, most organizations don’t have a fleet of battle-tested CPAs to fully leverage pro formas, especially startups and small businesses. Therefore, we again recommend checking out our Ultimate Guide to Pro Forma Financial Statements, where you’ll find even deeper insights and best practices. And just remember – if it all still seems a bit much, Embark is always around to swoop in and save the day.

Establishing the value of goodwill using the excess earnings method

Unlike traditional financial statements that explain the past, pro forma documents usually look forward and rely on financial modeling and speculation. If you want to plan for upcoming economic changes, you need pro forma financial statements to predict future income, identify and control risks, and secure funding for your business. Planning and budgeting for business changes play crucial roles in operating a successful company. However, balance sheets, income statements, and similar finance-tracking documents focus only on the history of transactions and the current economic status of your company. We’re going to take you through the steps necessary to create a basic full-year pro forma projection using an income statement, cash flow statement, and balance sheet.

  • The types of pro forma statements are Pro forma of historical profit and loss statements and Pro forma projections of income.
  • If you take out the loan, you might share the pro forma financial statements with the lender to demonstrate your ability to repay the loan.
  • Let’s understand why a business entity prepares a pro forma statement or its purpose.
  • A pro forma financial statement is one based on certain assumptions and projections (as opposed to the typical financial statement based on actual past transactions).

Depending on the specialty, the new to established ratio will even out over time, as well as existing physicians’ revenue and compensation. When building pro forma financial statements, be sure to use realistic, conservative figures. If outside funds are needed, pro forma statements can help present the expected future results to lenders and other investors. Managers can use pro forma statements for a variety of reasons to illustrate the effects of executive decisions or expected changes in business. Often, events depicted in the pro-forma financial statements have yet to occur, so the actual financial picture of the company may be very different from the picture presented.

What are pro forma financial statements?

This projection looks backward (at one or more years) at another company’s financial statements. Using this combination, the projections shows how they would have done together. This type of projection could be shorter term (from the beginning of the current fiscal year). Use this free template to create your own historical with acquisition pro forma documents. Whether you’re trying to interpret pro forma financial statements or prepare them, these projections can be useful in guiding important business decisions. In fact, business owners, investors, creditors, and other key decision-makers all use pro forma financial statements to measure the potential impact of business decisions.

Pro Forma Statements of Cash Flow

This metric determines the financial outcomes of any acquisition or merger and tells the parent company whether the transaction will be accretive (good) or dilutive (bad) to the financial state of the company. Pro forma EPS are calculated in the pro forma income statement, but the figure is also used in the pro forma balance sheet and the pro forma cash flow statement, when necessary. According to the SEC, when the dividends from stock exceed or are planned to exceed the current earnings, the EPS must be calculated. The SEC assumes that that proceeds from any additional shares will be used to fund dividends. Statements of cash flow, or cash flow statements, measure the sources of a company’s cash and how it uses that cash over the stated period. Pro forma statements of cash flow estimate how much cash inflow and outflow is expected in one or more future periods.

Pro forma financial statement definition

These projected financial statements are referred to as pro forma financial statements. Traditionally, financial statement analysis is used to better understand a company’s performance over a specified period. While this provides insight into a company’s historical health, creating pro forma financial statements focuses on its future. For this reason, these reports can be leveraged in several ways, including analyzing risk, projecting investments, and showing expected results before the end of a reporting period.

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. Since pro forma financial statements and financial projections are quite similar, they may be considered synonymous.

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. Simply, a “pro forma invoice” is a “confirmed purchase order” where buyer and supplier agree on detail and cost of the product to be shipped to the buyer.

We’re America’s largest bookkeeping service helping thousands of business owners better understand the financial health of their operations so they can keep focused on growth and planning. When it comes time to create a pro forma statement, you have reliable numbers and reports to get started. This type of pro forma projection looks at the past financial statements of your business, plus the past financial statements of a business you want to buy.

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. If the required commercial invoice is needed for statistical purposes, the importer has to produce the commercial invoice within 50 days from the date Customs releases the goods to the importer. 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.

So it’s best to use them in combination with other tools such as balance sheets, income statements, economic audits, and more. Generally, pro forma financial statements tend to portray a business as being more successful than it really is, and having more financial resources available than may actually be the case. Consequently, investors should be extremely cautious when evaluating these types of financial statements, and spend time understanding how they differ from the issuing firm’s normal financial statements. Pro forma financial statements are financial reports issued by an entity, using assumptions or hypothetical conditions about events that may have occurred in the past or which may occur in the future. These statements are used to present a view of corporate results to outsiders, perhaps as part of an investment or lending proposal. A budget may also be considered a variation on pro forma financial statements, since it presents the projected results of an organization during a future period, based on certain assumptions.

However, we’re lobbing another caveat your way – take our walk-throughs with a grain of salt since they’re only a glimpse into the basic pro forma process. Also, it’s important to remember the SEC, AICPA, and FASB have specific guidelines regarding the form, content, and necessity of pro forma financials under particular circumstances. Therefore, whatever prompts the need for them, you must adhere to any mandatory guidelines involved. To take a gander at what’s coming down the pike, adjust accordingly, and knock business decision after business decision out of the park. 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. The pro forma accounting is a statement of the company’s financial activities while excluding “unusual and nonrecurring transactions” when stating how much money the company actually made.

In creating your pro forma documents, it is advisable to create multiple sets with different scenarios, especially when their purpose is to help make decisions. In this way, your management team (or C-suite) has all the information they need to make informed decisions. If you enable them, they have the best and worst-case scenarios immediate annuities explained that review the fiscal impact of their decisions and possible ways to mitigate risk. For more information on conducting risk analyses and the free templates to do so, see “All the Risk Assessment Matrix Templates You Need.” As an example, your team might need to decide between the acquisition of two separate businesses.

While they all fall into the same categories—income statement, balance sheet, and cash flow statement—they differ based on the purpose of the financial forecast. In simpler words, we can define pro forma statements as the company’s financial statements that give insights or estimations of future financial performance. Building accurate pro forma financials requires an in-depth financial analysis of your present business. When creating pro forma financial statements, ask an accountant to provide additional guidance.