Because these govern bookkeeping and accounting practices, including how we make financial reports they must use real historical data. Unlike pro forma statements, we can use these documents for tax preparation and filing. Whether done knowingly or unknowingly, serving pro forma statements as if they were GAAP compliant statements can get you in trouble. Pro forma financial statements are financial reports based on hypothetical scenarios that utilise assumptions or financial projections. Building accurate pro forma financials requires an in-depth financial analysis of your present business.
- Every investor should stress GAAP net income, which is the “official” profitability determined by accountants, but a look at pro-forma earnings can also be an informative exercise.
- Start with an income statement from your most recent fiscal year and identify which items you’ll adjust for the projection.
- Still, there may be some gray areas, so use caution when relying on future projections.
- These statements are used to present a view of corporate results to outsiders, perhaps as part of an investment or lending proposal.
Internal teams can view the information in these statements to weigh multiple options for moving the business forward. Investors can look at these to see a glimpse of their potential impact if they were to finance a business. Business owners can also look at pro formas forecasting the outcomes of a merger or acquisition deal. Pro forma income statements are useful because they can reveal how a potential transaction changes certain elements on the statements. For instance, how revenues change in a merger or acquisition or how much more taxes you might need to pay. Alternatively, when you want to demonstrate the impact of different capital investment amounts, you can create multiple pro formas so a potential investor can see the varying effects on, as an example, the pro forma balance sheet.
Historical with Acquisition Pro Forma Template
When deciding whether or not to invest in a company or a project, it’s reasonable to wonder how the future will unfold. There’s no way to predict the future with certainty, but you can analyze multiple “what if” scenarios to understand the potential outcomes. Pro forma financial statements enable investors to do that with available information. Every small business should create a budget, and the budgeted financial results are pro forma statements. An owner may create pro forma reports to assess the potential profitability of a product, or to determine if a business expansion makes financial sense. Often, the difference between a past balance sheet and a pro forma balance sheet is that the pro forma balance sheet reports additional periods, sometimes even interim figures.
Risk analysis lets you take the future for a test ride, and try out different outcomes. This type of pro forma projection takes into account all of your financials for the fiscal year up until the present time, then adds projected outcomes for the remainder of the year. That can help you show investors or partners what business finances could look like by the end of the fiscal year.
The Bottom LineTo sum up, pro-forma earnings are informative when official earnings are blurred by large amounts of asset depreciation and goodwill. But, when you see pro forma, it’s up to you to dig deeper to see why the company is treating its earnings as such. 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.
In trade transactions, a pro forma invoice is a document that states a commitment from the seller to sell goods to the buyer at specified prices and terms. It is not a true invoice because it is not used to record accounts receivable for the seller and accounts payable for the buyer. The term is used in legal and business fields to refer to various types of documents that are generated as a matter of course.
- It shows you what you earn and spend on operating, investing, and financing activities.
- This is the main limitation of pro forma because these scenarios hinge on multiple factors going the way you expect them to.
- Therefore, to paraphrase Merriam-Webster, pro formas involve or are based on a suggested idea or theory.
If you take out the loan, you might share the pro forma financial statements with the lender to demonstrate your ability to repay the loan. Businesses also use pro forma financial statements to prod investors to provide capital. Small business owners can use pro forma statements to draft forecasted financial statements, budgets, and quotes. While it’s helpful to know what a company’s management has planned, it’s important to view these projections with skepticism.
Creating Pro Forma Financial Statements
The sales total and customer payment history help the firm determine the accounts receivable balance. There are both benefits and downsides to the assumption structure that pro forma is built upon. We expect to offer our courses in additional languages in the future but, at this time, HBS Online can only be provided in English. Our platform features short, highly produced videos of HBS faculty and guest business experts, interactive graphs and exercises, cold calls to keep you engaged, and opportunities to contribute to a vibrant online community.
How do pro forma financial statements differ from historical financial 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. Pro forma statements offer a realistic estimate of what a merger would look like. For instance, “They can help you identify redundancies, and any new addition that needs to be made,” said Taylor. For example, through pro forma statements, you can identify that you may not need two accounting departments and two HR functions in a merger.
Other Pro Forma Scenarios
You can use this scenario as a model of what may happen in the future if you buy the other business and restructure now. For these purposes, pro forma statements are typically created as a part of a financial forecast in financial accounting. Big corporations who have in-house accountants use pro forma statements for financial modeling and forecasting different scenarios.
This isn’t to say companies are always dishonest with pro-forma earnings – pro forma doesn’t mean the numbers are automatically being manipulated. But by being skeptical when reading pro-forma earnings, you may end up saving yourself big money. To evaluate the legitimacy of pro-forma earnings, be sure to look at what the excluded costs are and decide whether or not these costs are real.
Russell creates a pro forma income statement for next year to inform his decision. Russell follows The Ascent’s guide to forecasted financial statements to generate the document. Since we can’t predict the future, don’t rely solely on pro forma financial statements.
How To Prepare Pro Forma Statements
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. We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. Editorial content from The Ascent return on invested capital roic formula is separate from The Motley Fool editorial content and is created by a different analyst team. Businesses create annual budgets that fall in line with a company’s profitability and production goals. In law, pro forma court rulings are intended merely to facilitate the legal process (indeed to move matters along). Sally uses her sales estimate to estimate the dollar amount of inventory at the end of 2021.
A pro forma income statement would show how the company’s revenues and expenses might change and ultimately affect company profits. Income statements would show how much it would cost a company to pursue the project and how much revenues might improve after completion. With Bench, you get a crystal clear image of your financial history so you can focus on planning your future. We’re America’s largest bookkeeping service helping thousands of business owners better understand the financial health of their operations so they can keep focused on growth and planning. When it comes time to create a pro forma statement, you have reliable numbers and reports to get started.