In accounting, pro forma refers to financial reports based on assumptions and hypothetical situations, not reality. Businesses use pro forma financial documents internally to aid in decision-making and externally to showcase the effect of business decisions. 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. 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.

Remember, what distinguishes these pro forma statements from your standard financials are the adjustments, not the calculations or even the format. Certain regulatory bodies and scenarios will require specific information but, from a foundational perspective, the framework for each is essentially the same as what you already use when preparing your financials. Keep in mind that the American Institute of Certified Public Accountants (AICPA), and the Securities and Exchange Commission (SEC) both have guidelines for creating pro forma statements. Here’s a historical example of a pro forma income statement, courtesy of Tesla Inc.’s (TSLA) unaudited pro forma condensed and consolidated income statement for the year ended Dec. 31, 2016. Pro forma financials are not computed using generally accepted accounting principles (GAAP) and usually leave out one-time expenses that are not part of normal company operations, such as restructuring costs following a merger.

• When building pro forma financial statements, be sure to use realistic, conservative figures.
• Management prepares projections for the next several years of the expected revenue increase and the rise in costs of operations.
• 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.
• A pro forma statement of cash flow can be helpful in determining when there might be a shortage of cash, which could help determine whether cutting expenditures or taking on a loan could help.
• In many cases, pro forma statements (or at least some form of financial projections) are prerequisites for investment.
• 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).

Taking an online course like Financial Accounting can help you understand how to create and interpret different kinds of financial statements so you can find meaning in them. Learners enrolled in the course learn the language of accounting and how to create financial statements and forecasts to make strategic decisions. The percent of a sales forecasting method, for example, involves determining future expected sales and finding trends across accounts in statements. Use the templates found here to create your own cash flow statement forecast. Change the dates and time periods to reflect the projection you need to create. A pro-forma forecast, similar to any sort of pro-forma report, is not required to abide by GAAP.

Why create pro forma statements?

Do your homework and maintain a balanced perspective when reading pro-forma statements. Try to identify the key differences between GAAP earnings and pro-forma earnings, and determine whether the differences are reasonable or if they are only there to make a losing company look better. You want to base your decisions on as clear a financial picture as possible – regardless of whether it comes from pro-forma earnings or not. Management’s responsibility is to never get caught by surprise, anticipate changes and always be prepared for upcoming conditions.

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. 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 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. You could deliver to them two sets of pro forma financial statements, and two risk assessment templates to use to discover their best option.

Pro forma statements of cash flow estimate how much cash inflow and outflow is expected in one or more future periods. Often requested by banks, they may also be prepared as a part of the annual budgeting or forecast and estimate where cash shortages may occur in order to obtain additional funding. In the case of estimated cash overages, the company can produce a plan for investment. Arguably, the statement of cash flow is the most important of the pro forma documents. If the pro forma balance sheet and income statements lead to a statement of cash flow that shows inadequate funds for what management has planned, the other documents will be invalid and may need to be reworked.

• If they are granted the patent, they will be the only company that can use this new technology for 10 years.
• Big corporations who have in-house accountants use pro forma statements for financial modeling and forecasting different scenarios.
• For example, the company might have to pay for land, materials, and fees to contractors who build the facility.

A budget anticipates the inflow of projected revenues and the outflow of funds for a defined future period, usually a fiscal year. 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. Report on key metrics and get real-time visibility into work as it happens with roll-up reports, dashboards, and automated workflows built to keep your team connected and informed. Owner’s equity represents the net value of a company, calculated by subtracting total liabilities from total assets. Any forecasted changes to owner’s equity, such as new investments or withdrawals by the owner, should be considered.

It may be tempting to think of a pro forma statement as the same as a business budget. Pro forma statements don’t need to meet the strictest accounting standards, but must be clearly marked as “pro forma” and can’t be used for things like filing taxes. Using pro forma statements that aren’t marked as such to misrepresent your business to investors, the IRS, or financial institutions can be penalized by the Securities and Exchange Commission). In conclusion, while the sales forecast is a significant part of the pro forma income statement, it’s essential to consider other factors to ensure the statement is as accurate and comprehensive as possible. 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. Forecasts made from these financial statements may or may not contain an even higher degree of deviation from the actual state of the company.

Other Pro Forma Scenarios

If the water feels too cold – the pro forma financial projections and expected results aren’t favorable – it’s probably not a great idea to take a dip. 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. Then it merges them to show what your financials would have looked like if you made a business combination (or merger) earlier.

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. To illustrate the process of creating pro forma financial statements, meet Sally, the owner of Centerfield Sporting Goods.

Russell follows The Ascent’s guide to forecasted financial statements to generate the document. Before acquiring another business, investing in new equipment, or taking on new debt, businesses draft forward-looking pro forma financial statements to understand the effect. 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. This approach is useful for seeing how a prospective acquisition could have altered the financial results of the acquiring entity.

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Remember that when you read pro-forma figures, they have not undergone the same level of scrutiny as GAAP earnings and are not subject to the same level of regulation. There’s a clever way in which companies fudge and fiddle with their earnings figures and you should know about it. The Securities and Exchange Commission (SEC) will investigate companies suspected of trying to deceive investors in the pro-forma modification of earnings. Let’s take a look at what pro-forma earnings are, when they are useful and how companies can use them to dupe investors. Pro forma projections could shed some light on the best-case and worst-case scenarios. Suppose a company has recently gone through a substantial restructuring program.

Forecasted Market Changes That May Affect Expenses

A normal balance sheet covers two years, but it is reasonable for a pro forma balance sheet to cover four years of operations. Using pro forma templates can save you valuable time when creating financial forecasting vs financial modeling your own pro forma income statements. In the business lending world, lenders will look at a company’s pro forma balance sheet to determine the debt-to-equity ratio for additional lending.

While pro forma financials are useful for management to evaluate the consequences of various alternatives, they can sometimes present more optimistic pictures of future results. GAAP requirements are often omitted from pro forma statements because they result in more negative reporting. Russell creates a pro forma income statement for next year to inform his decision.

Pro forma financial statement definition

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.

Check the templates in this guide to determine which is right for you to create your own. According to the SEC, for public companies, a pro forma balance sheet should have the same dates, plus one year from the last submitted balance sheet. If interim period balance sheets were submitted, the company should pick up from where they left off. If it is an annual period, the document should also align with the company’s filed GAAP-approved financial statements. A pro forma balance sheet is a comparison of a business’ assets and liabilities. The pro forma part of the balance sheet is a projection that looks ahead, assuming certain things will occur.

In other words, pro forma financial statements start from real financial data. Pro forma analyses are meant to paint a better picture of what is happening with the company, irrespective of one-time events, but considering the specific industry’s standards. In some respects, this type of analysis is a more accurate depiction of the company’s financial health and outlook.