Everything you need to know about Pro Forma Statements

Rishan was all excited about his new business, but things took a turn for the worse pretty quickly. He didn't plan for the 'what if' scenarios for his company's future earnings. Long story short, he overestimated his sales and underestimated the costs. This made it tough to stick to a budget, and before he knew it, he was in a cash crunch. All these could have been avoided with the Pro forma financial statements or "what-if" generators. The term "pro forma" is roughly translated as "for form" or "as a matter of form." 

What is Pro forma, and why is it important?

Pro forma statements help business owners, investors, creditors, and decision-makers make informed decisions by predicting future scenarios and outcomes using hypothetical scenarios.

In the world of business, numbers are key to making informed decisions. While financial statements like balance sheets and income statements give a glimpse into a company's past performance, they may not offer much insight into the future. That's where forecasts and financial projections come in, providing important information for planning and addressing the what-if scenarios.

Why create pro forma statements?

• Pro forma statements can help businesses:
• Attract investment by showing how funds will be used for business expansion and growth
• Strategically planning for the future by analysing best, worst, and most likely case scenarios to assess risks and opportunities
• Prepare for potential changes that may impact the business, like moving into a higher tax bracket.

Types of pro forma statement

‍

Purpose of Pro forma statements

Full-year pro forma projection

This kind of prediction looks at all your finances from the start of the fiscal year to now and predicts what's coming for the rest of the year. It's a way to show investors or partners where your business could be financially by the end of the year.

Financing or investment pro forma projection

If you're trying to attract investors or persuade your business partners to invest more money, a funding projection can help you make your point. This projection considers the cash from external sources and any interest payments you might have to make and shows how it will impact your financial situation.

Historical with acquisition pro forma projection

This projection combines your past financial records with those of a company you're eyeing for acquisition. It merges them to give you an idea of what your finances would've looked like if you had merged earlier. This gives a good idea of how the merger or acquisition could affect the company's financial health.

‍

Risk analysis pro forma projection

This considers both best and worst-case situations to help you make better decisions. What if your vendor raises prices? How will you manage? Risk analysis lets you peek into possible futures and explore different outcomes before they happen.

‍

How to create a Pro forma financial statement?

• To start, set a sales target for the upcoming period. 
• Then, craft a production plan that aligns with this goal and distribute it over the timeframe. 
• Consider how you'll meet this production plan - steadily boosting monthly sales or gradually upping your sales targets. 
• Next, calculate the COGS and subtract it, along with other operating expenses, from your sales. Finally, based on the information gathered in the earlier steps, a pro forma income statement will be put together.

Also read: Form 1120

To create a pro forma balance sheet

• Start by moving the retained earnings adjustment from the pro forma income statement to the balance sheet. 
• Then, analyse any modifications needed for current assets and liabilities based on the sales variance in your forecast. Finally, include assets, owner's equity, and total liabilities to finalize the pro forma balance sheet.

To create a pro forma cash flow statement

• Let's start by combining the cash you have on hand with cash receipts like sales, loans, and interest. 
• Next, jot down all the cash outflow for sales and salary costs. 
• Then, sum up your operating expenses and other costs such as income taxes and cash payments. 
• After factoring in all the other costs, such as taxes and cash payments, sum up total cash outflows, net cash difference, and final cash balance to wrap up your pro forma cash flow statement.

Note: Keep your bookkeeping updated so your pro forma statements will be more accurate. This will help you make realistic future projections based on the current state of your business.

‍

Conclusion

Pro forma statements are like crystal balls for your business, giving you a sneak peek into what could happen in different scenarios. But remember, they're just educated guesses, not cold hard facts. So, don't go all-in on a pro forma statement alone when making big decisions. 

Inkle Books is a bookkeeping tool that helps modern startups manage finances better.

Easily integrate your data sources, get your accounts in order, and track your books to know exactly where your money is going. With real-time updates and snazzy reports at your fingertips, managing your finances has never been easier!

Connect with us on LinkedIn.