What are Pro Forma Financial Statements?
A pro forma financial statement is a record ready foundation on estimates, assumptions, or even projections. To put it differently, it’s not a formal GAAP announcement issued to creditors and investors to relay info about previous company performance. Rather, it’s an instrument made by management to help project future operation and plan future events.
You can imagine this like a “what if” fiscal statement. What will the money flow statement look like this occurred? Management is hoping to determine what the company looks like when a company event takes place in the long run by beginning with conventional accounts and adjusting it to the projections.
These accounts are usually employed for internal planning purposes, but a lot of businesses do question them to the people for speculative purposes. For example, management typically speaks about the rise of the business in the management discussion and analysis part of the yearly report. In case their growth projections are predicated on landing a new customer or job, they may incorporate an estimated revenue statement to reveal that the impacts of the new job on the most important thing.
Pro forma financial statements could be ready independently or at a place such as general-purpose financials. Let’s look at every record from the set and management would opt to conceive a pro-forma model.
Pro Forma Income Statement
The earnings statement is most likely the most frequently expert forma-ed financial announcement because investors, investors, and lenders all want to find out what happens to benefits whether particular company trades come to pass later on. Therefore, direction will conceive an estimated revenue statement based on particular assumptions.
For instance, management may expect closing a supply agreement with Wal-Mart at the subsequent six months which will cause an extra $5M in earnings. Management will begin with the conventional revenue statement and include the projected $5M earnings projection together with the corresponding expenditures necessary to make and ship these products to the distributor. In the event the upcoming agreement with Wal-Mart goes through, the business is ready for investors and investors and lenders have a notion concerning the risks and benefits involved later on.
Pro Forma Balance Sheet
Estimating and projecting the balance sheet is also a frequent practice since investors and lenders wish to utilize the balance sheet to examine debt rates, liquidity levels, and total leverage of the provider.
Going back into our Wal-Mart instance, allow’s presume the corporation may support that many buy orders and has to draw a line of credit in order to fund it. Now the projected sale has not only put more income on the bottom line, but it has also put more debt on the balance sheet.
Creditors, in particular, would be concerned about this because additional debt might violate preexisting debt covenants. Meanwhile, investors might not care because the growth in income outweighs the development in debt.
Pro Forma Cash Flow Statement
Typically a projected cash flow statement is not issued to the public. Instead management uses it to analyze what would happen to current inflows and outflows of cash if a business deal happened in the future.
In our Wal-Mart example, the company would receive a large amount of cash from the line of credit and the new sales. It would also have additional cash outflows funding the extra buy orders and paying the interest and principle on the new debt.
As you can see, pro forma financial statements are a great tool that management can use to play out what-if scenarios and future projects. They is used to plan the future by evaluating upcoming cash requirements, credit terms on new debt obligations, and the logistics of entering into new contracts.
Management uses these reports regularly in the course of business and only occasionally issues them to outside investors and creditors.