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. Many of the items listed above are part of the GAAP, but not included in pro forma reporting, making it rife for possible deception.

For more information, please see the SEC’s Web Site Privacy and Security Policy. Sally uses her sales estimate to estimate the dollar amount of inventory at the end of 2021. The sales total and customer payment history help the firm determine the accounts receivable balance. As an example, he explained that if the base case is that revenue grows by 20% over the next few years, one may want to lower that projected growth rate to, say, 10%, to see how the firm’s financials look.

Examples of expenses often excluded from pro forma results are company restructuring costs, a decline in the value of the company’s investments, or other accounting charges, such as adjusting the current balance sheet to fix faulty accounting practices in previous years. To make that happen, you have to frequently make informed projections about sales, production, and costs. Pro forma financial statements are a great way to assess the financial impact of those assumptions. “A key element of pro forma financials is that they allow analysts to change one or more key variables and see how the financial statements appear if certain variables are more or less optimistic than the base case,” Johnson said.

What Is Pro Forma?

It is also important to understand any limitations of the statements such as assumptions about sales growth or cost increases. Furthermore, it is important to understand any external factors that could affect the accuracy of the projections such as changes in customer preferences or competitive environment. Other than the procedures applied to the historical financial statements,fn 6 the procedures the practitioner should apply to the assumptions and pro forma adjustments for either an examination or a review engagement are as follows. There can be a lot of problems if the company’s management decides to issue its pro forma statements to the general public. This is because they will contain many assumptions and hypothetical cases based on the management’s beliefs about future business conditions. In reality, events might significantly differ from what is expected and therefore in retrospect, the pro forma statements can be called out by the investors as highly inaccurate.

You can also sign up for email updates on the SEC open data program, including best practices that make it more efficient to download data, and SEC.gov enhancements that may impact scripted downloading processes. In the Parliament of the United Kingdom, the equivalents are the Outlawries Bill in the House of Commons and the Select Vestries Bill in the House of Lords. In the Parliament of Canada, such bills are titled Bill C-1, An Act respecting the Administration of Oaths of Office, and Bill S-1, An Act relating to Railways in the House of Commons of Canada and Senate of Canada, respectively. In the Australian House of Representatives, a new bill is drafted at the start of each parliamentary term (in the 47th Parliament this was the Customs Amendment Bill 2022) and presented by the Prime Minister. This practice does not extend to the Australian Senate; instead other formal business is conducted (such as question time) before consideration of the governor-general’s speech.

Length of a Forecast

Thus, we would likely look at the history of the dollar values of fixed costs in order to forecast them. Financial professionals use an accounting system to prioritize accuracy in these projections. Individual businesses may allow for variations of operations for creating 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. Pro forma earnings per share (EPS) are calculated by dividing a firm’s net income (and any adjustments) what are adjusting entries by its weighted shares outstanding, plus any new shares issued due to an acquisition. 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.

Best Practices for Interpreting Pro Forma Financial Statements

And as we mentioned earlier, they are not in compliance with GAAP, which means they have to be labeled as pro forma and cannot replace formal financial statements. 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. Another important thing to remember when preparing pro forma statements is to use credible data and not over-rely on hypothetical information, so your estimates are as close to accurate as possible. Taylor suggested starting the process with actual data that has been audited (if you have an auditor), or at a minimum have been validated as accurate.

The sample pro forma statements below may look different from the statements you create, depending on what your template looks like. But generally, these are the steps you need to take to create them—and the info your pro forma statements should include. A company may present a pro forma statement to inform investors about their internal assessment of the financial outcome of a proposed change in the business. 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. Pro forma means “for the sake of form” or “as a matter of form.” When it appears in financial statements, it indicates that a method of calculating financial results using certain projections or presumptions has been used.

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It is usually prepared by management and is used to help in the analysis of certain economic conditions, business decisions, deals, mergers or acquisitions, and other events. If your business is looking to the next month, quarter, or fiscal year, pro forma financial statements are an indispensable tool for prioritizing your finances. Unfortunately, the cost and time required to develop pro forma projections in-house may make them unattainable for your business at this time. When it comes to accounting, pro forma statements are financial reports for your business based on hypothetical scenarios. They’re a way for you to test out situations you think may happen in the future to help you make business decisions.

• Thus, we would likely look at the history of the dollar values of fixed costs in order to forecast them.
• ●  investing activities such as movements in capital assets including building, equipment, land, business acquisitions, etc.
• Asides from assessing the financial results of day-to-day operations, pro forma financial statements can also be used to evaluate the financial impact of key capital investments and major restructuring projects on the overall business or organization.
• Pro forma means “for the sake of form” or “as a matter of form.” When it appears in financial statements, it indicates that a method of calculating financial results using certain projections or presumptions has been used.

Pro forma statements do not follow the generally accepted accounting principles (GAAP), because reports that comply with GAAP must rely on historical data and not anticipated cash flow. Creating a pro forma statement is important because it allows management to see the possible outcomes of a decision. This information is crucial in making informed decisions about events or transactions that could have a significant impact on the company.

Other Types of Pro Forma Financial Statement Templates

For example, sales might be presented as 15% higher (best case), 5% higher (expected), 20% lower (worst case). If material costs increase sharply, or there is a shortage of labor, the cost of sales will increase. So far, we have focused on using historical common-size statements to create a draft (not a final version) of the forecast. This is because the past isn’t always a perfect indicator of the future, and our finances don’t always follow a linear pattern.

As such, they should be used with caution and not be used as a substitute for traditional financial statements. Furthermore, pro forma financial statements cannot account for all possible external factors that could affect a company’s future performance. For example, pro forma financial statements cannot account for changes in customer preferences or new competition entering the market. Pro forma financials offer businesses ways to make realistic assumptions about future growth rates and costs. According to Johnson, this is useful when you’re seeking outside capital (either debt or equity) to grow. “Potential capital suppliers will carefully examine pro forma financial statements (and the critical assumptions used in creating them) before committing capital to the firm,” Johnson said.

As mentioned earlier in the chapter, forecasts serve different purposes depending on who is using them. In this realm, the key purpose of pro forma (future-looking) financial statements is to manage a firm’s cash flow and assess the overall value that the firm is generating through future sales growth. Growing just for the sake of growing doesn’t always yield favorable income for the firm. A larger top-line sales figure that results in lower net income doesn’t make sense in the grand scheme of things. The same is true of profitable sales that don’t generate enough cash flows at the right time.

The COGS figure does directly vary with sales; if it does not, something is wrong with your numbers. The COGS forecast is the COGS/Sales ratio from several years multiplied by the sales forecast. You can address this fact simply with a final paragraph in the compilation reports, and the author may elect to include the reason for the lack of independence. Finally, in each page of the pro forma information, there must be a reference to the compilation report. Essentially, a pro forma financial statement can exclude anything a company believes obscures the accuracy of its financial outlook and can be a useful piece of information to help assess a company’s future prospects.

No matter how good or bad that portrayal may seem, it’s only a good guess as to what may happen. There are both benefits and downsides to the assumption structure that pro forma is built upon. These projections are generally made several years out into the future and are used as inputs into the valuation process, said Robert R. Johnson, professor of finance, Heider College of Business, Creighton University, in a separate email interview with The Balance.

Historical statements should be real, solid, and scientific, while pro forma statements allow management to exercise a certain amount of creativity and flexibility. Pro forma statements reflect a dynamic environment in which change is still possible and a variety of different alternatives can be followed. They take the same forms as historical statements, the most common being the income statement, the balance sheet, and the statement of changes in financial position. Preparing pro forma financial statements requires a comprehensive understanding of accounting principles and an understanding of the company’s current financial situation. To begin, start by gathering all relevant information about the company such as its current assets and liabilities, income statement, cash flow statement, and balance sheet. Next, gather any additional information that may be relevant such as projections for sales and expenses or changes in capital structure.