Then it merges them to show what your financials would have looked like if you made a business combination (or merger) earlier. You can use this scenario as a model of what may happen in the future if you buy the other business and restructure now. It may be tempting to think of a pro forma statement as the same as a business budget. For example, if a company spends $50 million restructuring its business, GAAP rules require this cost to be included in earnings. However, in its pro forma statements, the company might exclude this expense, arguing it’s a one-time event that doesn’t reflect ongoing business performance.
Components of Pro Forma Financial Statements
Companies that provide large dollar amounts of stock-based compensation will incur expenses that must be recorded on the income statement. If a company division is losing money, pro forma reports can estimate the cost of closing the division completely. Management may decide to operate at a loss until long-term liabilities, such as lease agreements, are paid in full. Assume a new product launch will increase revenue by 15% in the next fiscal year. Pricing is based on high demand for the product, and if the cost of sales is controlled, the company’s profitability moves higher.
- A pro forma cash flow statement forecasts the net cash flow of a company for future periods.
- The three primary types are the pro forma income statement, pro forma balance sheet, and pro forma cash flow statement.
- Moreover, pro forma financial statements help investors identify potential red flags that might not be apparent in historical financial reports.
- Imagine we’re looking at “Bea’s Boutique,” a small but spirited clothing store nestled in the heart of a bustling neighborhood.
- While they offer valuable insights, projections are estimates, so it’s important to account for potential variability.
What is Accounting and Why it Matters For Your Business
Start by taking the information from your income statement and using the cash flow statement to determine where your money is going. This statement can be part of a larger cash flow that’s used for financial accounting and decision-making. You might be wondering how a pro forma balance sheet differs from a budget, as it’s likely tempting to think about the two as the same thing. Although the two documents share commonalities, they are two distinct financial tools that you can use to benefit your business. At Cultivate Advisors, our revenue management consultants can help you put together a pro forma income statement to give you confidence and insight into how your company will perform in various scenarios.
She factors in the cost of renovations, additional inventory purchases, and potential increases in staffing. For her cash flow projections, she considers the timing of her investment and the gradual increase in sales. It’s a balancing act, ensuring she has enough cash on hand to cover expenses during the renovation phase.
#1 — Pro Forma of Historical Profit and Loss Statement
If we want to extend this forecast further into the future, we simply focus on increasing our revenue-driving activities (as long as they’re working). When we have some idea of how we’re going to drive sales, we can look at how the transaction between the business and the customer occurs, which is a critical part of our revenue model. There are many different revenue drivers, but our chosen method for generating new business should be appropriate for the amount we charge customers. We don’t want to spend three months courting a new client to sell them a $20 product. Alternatively, we likely won’t sell a $100,000 service with a couple of Google ads – although it could be the first step. We use revenue drivers because it’s a lot easier to control the number of cold calls we make each day versus the sales we make from cold calls.
When companies merge or acquire another, they create pro forma statements to show the financial impact. For example, when Microsoft Corporation (MSFT) acquired Activision Blizzard in 2023, it created pro forma statements showing how combining the two companies would affect revenues, costs, and profits. By allowing publicly traded companies to adjust for one-time expenses or pro forma income statement non-recurring events, it provides a clearer picture of ongoing performance in compliance with GAAP. By excluding anomalies, such as a legal settlement, these statements present a more accurate view of current and future financial health. This clarity is critical for stakeholders, as it mitigates the negative perceptions caused by temporary financial setbacks.
Definition and purpose of pro forma income statements
It combines these numbers to showcase what your financials would have looked like in the case that you combined businesses earlier. You can use this data from the proposed transaction as a guide to what your projected income statement would be in the future and restructure from there. Creating pro forma statements allows businesses to perform risk analysis by simulating different scenarios.
The income statement is produced for a specific period (month, quarter, etc.), and the matching principle matches revenue earned with expenses incurred to grow revenue. Our intuitive software automates the busywork with powerful tools and features designed to help you simplify your financial management and make informed business decisions. This happens when the business plans to make some retrospective changes in the income statement.
- Creating a variety of hypothetical scenarios can help gain insight into the potential financial impacts of different decisions, risks, and opportunities.
- For instance, an investor considering funding a startup might use pro forma projections to evaluate the potential impact of different growth strategies on revenue and profitability.
- A pro forma income statement is simply a future version of an income statement.
- Ignoring these elements can result in a disconnect between projected figures and actual performance.
- She surveys her customers, chats with other local business owners, and keeps an eye on upcoming fashion trends.
Bea projects a 20% increase in sales for the next year, keeping her estimates conservative to stay grounded. This wasn’t just any oven; it was the heart of the bakery’s expansion plan, significantly impacting both assets and liabilities. The oversight led to a considerable underestimation of future liabilities (since the oven was to be financed) and, by extension, equity.
Pro forma income statements are not used to report actual financial performance. Pro forma income statements do not comply with Generally Accepted Accounting Principles (GAAP). A business valuation analysis should clearly state if pro forma financial statements are used. Standard Brands is a CPG company whose owner is building a pro forma income statement for 2025.
This document is like the hydration strategy for your marathon; it tracks the flow of cash in and the cash disbursements out of your business. It helps ensure you don’t run out of liquid assets (cash) by showing when you might need a financial water station. Breaking it down, it covers operating activities (daily business operations), investing activities (buying and selling assets), and financing activities (loans and investments).
Accounting software with advanced accounting capabilities, like QuickBooks, can help here. A pro forma income statement is a projection based on historical data and performance assumptions. Pro forma statements are often generated based on an account’s percentage of prior year sales or revenue. Business owners evaluate the financial accounting impact of adding a product line. A pro forma balance sheet projects the new financial position of the company, including assets, liabilities, equity, and the required capital investment.
These statements enable companies to evaluate the impact of hypothetical scenarios, such as an economic downturn or fluctuations in commodity prices, on their financial results. Businesses can then take proactive measures to mitigate risks and safeguard their financial health. Misleading or inaccurate pro forma statements can result in a loss of credibility and trust with stakeholders, making it crucial to approach them with integrity and objectivity. They create pro forma statements combining their own historical financial information with that of the acquisition target.
Including these components allows businesses to create a detailed view of their expected financial health, essential for effective financial forecasting and business planning. If you’re looking to learn about pro forma income statements, then you’ve come to the right place. Pro forma adjustments are modifications made to historical financial information to reflect potential changes in operations, transactions, or external factors. These adjustments allow businesses to model how future events will impact their financial statements. Pro forma financial statements play a vital role in financial modeling and planning for the future. Businesses use these statements to make financial assumptions about future performance and financial results.
Be advised that issuing pro forma financial statements to the public can be problematic, especially since the pro forma statements and the GAAP statements can vary so widely. Investors should be cautious when evaluating these types of statements because they present a considerably more favorable picture of the business. For the effects of the business combination, only show the current and immediately preceding periods. Using pro forma templates can save you valuable time when creating your own pro forma income statements.