Pro forma financial statements: what they mean and what they include

Pro forma financial statements are crucial for business owners aiming to make strategic decisions and forecast future financial outcomes. This blog outlines the importance of these statements, provides guidance on creating them, and explains how they can help you plan for growth and navigate financial challenges effectively.

Are you a small business owner eager to expand your operations?

You might be considering acquiring a new business, launching a new product line, or entering a new market. 

While these opportunities are exciting, they come with critical questions including but not limited to the following: 

• How will these decisions impact your financial future? 
• What if market conditions change? 
• How do you prepare for potential financial challenges?

That’s where pro forma financial statements come in.

Pro forma financial statements are powerful tools for forecasting potential financial outcomes based on various hypothetical ‘what-if’ scenarios such as the impact of hiring more staff, investing in new equipment, or facing unexpected expenses. They provide a way to model the financial effects of your business decisions, helping you confidently make informed choices.

In this blog, we’ll explore what pro forma financial statements are, how to create them, and why they are essential for growing your small business.

What does pro forma mean? 

The term “pro forma” is derived from Latin, meaning “for form.” In business, it refers to actions or documents created as a standard or formality. Specifically, a pro forma financial statement is a type of financial report that predicts the future performance of a company.

What is a pro forma statement?

Pro forma financial statements use hypothetical data or assumptions about future values—such as revenue, costs, and other financial indicators—to forecast a company’s financial performance. These projections are crucial for planning and decision-making, especially when considering investments, business deals, or strategic changes.

Typically, businesses use traditional financial statements like balance sheets, income (P&L) statements, and cash flow statements to review their historical performance. While these documents provide valuable insights into a company’s past financial health, pro forma financial statements are forward-looking and focus on the company’s future potential.

The idea is to predict and document your company’s future financial performance.

Why do you need a pro forma?

These financial statements are derived to anticipate future events, such as mergers, acquisitions, or other one-time restructurings.

• Aids decision-making: Pro forma financial statements help in making informed business decisions by providing a forward-looking perspective on potential financial outcomes.
• Strategic financial planning: These statements are crucial for strategic financial planning and analysis (FP&A), allowing you to forecast and analyze various financial scenarios.
• Scenario analysis: By creating pro forma financial statements for different investment scenarios, you can reflect the outcomes of various options.
• Side-by-side comparison: This approach allows you to conduct a side-by-side comparison of possible outcomes to determine which scenario is most favorable.
• Guides planning: The insights gained from pro forma comparisons can guide your strategic planning process and help you choose the best path forward.
• Influences investor perception: During fundraising efforts, investors often request to see financial projections. These projections and the assumptions behind them influence how investors perceive your company’s potential exit value and their expected return on investment (ROI).
• Showcases leadership forecasts: Pro forma statements provide insight into how your leadership team forecasts future performance, impacting investor confidence and decision-making.

When should you create a proforma statement?

Pro forma reports are very useful when it comes to making strategic business decisions. 

Imagine evaluating the potential outcomes of three different investment scenarios for your business. By creating pro forma financial statements, you can project the financial impact of each scenario. This side-by-side comparison helps you identify the most favorable option, providing clear insights that guide your strategic planning and decision-making process effectively.

Some of the aspects companies cover using pro forma statements are as follows: 

• Mergers and acquisitions: Companies commonly create pro forma financial statements to predict the combined financial growth of two entities and compare the results before and after the merger or acquisition. 
• Business restructuring: When companies expand their business (introduce new products or services), they use pro forma statements to suggest and analyze the financial position and overall impact of the expansion. This allows them to curate and implement cost-saving strategies.
• Initial public offerings (IPOs): Taking the example of Uber Technologies, Inc. forward, companies use pro forma statements to demonstrate their financial potential as a publicly traded company.
• Loan: Many businesses utilize pro forma statements to apply for loans. This allows them to gain their trust by demonstrating their ability to repay debt.

Pro forma financial statements: What’s included?

Although pro forma statements suggest the expected financial performance over many years, most investors require a minimum of three years. Most pro forma statements consider the three-statement model: income statement, balance sheet, and cash flow.

For example, it will give investors a forecasted revenue, expense, profit, or loss of your company in a certain quarter or fiscal year. It might use certain industry trends or expected changes in the financial policies implemented by the government. The key word here is projected future. 

How to create pro forma statements

Pro forma financial statements typically include several years of financial projections. While the exact duration can vary based on investor requests, we recommend starting with a three-year forecast.

At a minimum, most pro forma statements follow the “three statement model,” which includes:

• P&L statement (Net Profit/Loss): This statement projects future revenues, costs, and profits, providing a clear picture of expected profitability.
• Balance sheet: This shows the projected financial position of the business, including assets, liabilities, and equity, helping to assess overall financial health.
• Statement of cash flows: This outlines the expected cash inflows and outflows, ensuring you can anticipate and manage future liquidity needs.

Let’s learn how to create proforma statements in 4 steps:

1. Decide a time period and set a goal. For instance, you plan to earn $21,000 in a quarter. 
2. Plan out your schedule. Block and designate tasks during the quarter that will help you reach your final goal. For example, plan to earn $7,000 in every month of the quarter. You can also gradually reach your goal by planning to earn $5,000 in the first month of the quarter, $7,000 in the second, and $9,000 in the third quarter. 
3. You will now calculate and mark the cost of goods sold every month of the quarter. You will expand this projection by deducting this amount from your sales. Subtract any other expenses that you might spend from the sales. 
4. The pro forma income statement will be compiled using the data acquired from the first three steps.

Note: Make sure you are up-to-date with your bookkeeping because then your predictions would inch more towards accuracy.

Creating a pro forma cash flow statement

Creating a pro forma cash flow statement is not as daunting as it might seem at first glance. Start by creating a pro forma income statement. Once you have this data, you can format it into a cash flow statement.

What we mean by this is that the information from your pro forma income statement will show your projected revenues and expenses. You can then use this data to track where the money is expected to be used.

A well-made pro forma cash flow statement can help you forecast financial events and assist in decision-making. With predicted cash flow information, you gain insights that help you prepare for both positive and negative financial outcomes. 

Creating a pro forma balance sheet

Balance sheets are supposed to help you identify all the changes that occur over time in your business accounts — when certain transactions were made, how much was spent, where and if you recovered your costs — everything.

Both pro forma income statements and cash flow statements can help you create pro forma balance sheets. They are extremely useful and can help you see how you moved from Balance A to Balance B in your business dealings.

Creating a pro forma balance sheet follows a similar process. 

Begin with your pro forma income and cash flow statements. These documents provide the data needed to construct your balance sheet.

Using the information from these statements, you can outline your projected assets, liabilities, and equity. 

Pro forma statements vs. budgets

Now you must be wondering if budgets and pro forma statements are one and the same. You’re not the only one to confuse the two since both are used to predict future financial performance. But there is a slight distinction between the two. 

Pro forma statements are essentially predictions, whereas budgets are proper plans. Whenever you create a quarter-long budget for your company, you consider all the financial information you have at hand, which can be derived from pro forma statements. 

Curating your financial planning based on your predictions would make complete sense. With such financial projections, you can get insight into predicted revenues, expenses, and profit margins. Budgets are used to allocate where and how your capitol and resources will be used, and so you set goals and monitor performance. 

Problems with Pro Forma Analysis

It shouldn’t come as a surprise that pro forma statements can easily be manipulated. They aren’t based on facts — they use numbers to demonstrate a predicted future. 

Hence, when accountants and financial analysts want their ideas to be approved, they can malign pro forma statements to provide a more favorable picture. The loophole exists because there are no standardized guidelines to compile pro forma financial statements. 

Some of the significant components that are often neglected or hidden in pro forma statements include:

• the cost of restructuring
• interest rates and taxes
• amortization
• depreciation
• one-time expenses
• and even certain affiliated losses

It is important to mention the importance and usefulness of GAAP here because all the items mentioned above are included in it. This is exactly why they are standardized methods in the US, whereas pro forma financial statements aren’t. 

Now, don’t think of pro forma statements as misrepresentation. What should ideally happen is that when you create a pro forma financial statement to acquire funds from potential investors, you don’t leave out the aforementioned items. 

They must be given all the information so that they are able to get a holistic view of your company’s financial health. This way, investors can draw an accurate understanding and make comparisons. 

The bottom line

Pro forma financial statements are crucial for small business owners looking to forecast future financial outcomes and make informed decisions. Whether you’re contemplating an acquisition, anticipating changes in market conditions, or strategizing for growth, these statements provide a forward-looking perspective that helps you navigate potential challenges and opportunities with confidence.

Accurate financial projections start with a clear understanding of your current financial health. With CoCountant’s certified QuickBooks ProAdvisors keeping your books, you get a reliable foundation for creating precise pro forma statements: a detailed view of your financial history and all the accurate data you need to project future scenarios reliably.

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