Small business owners draft pro forma financial statements to quantify the impact of potential business decisions, such as taking out a loan to grow your business. Pro forma financial statements give you and your team something to consider before signing on the dotted line. The Securities and Exchange Commission (SEC) consistently updates its stringent rules on preparing pro forma statements for the public.
Pro-forma earnings describe a financial statement that has hypothetical amounts, or estimates, built into the data to give a “picture” of a company’s profits if certain nonrecurring items were excluded. Pro-forma earnings are not computed using standard 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. 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. 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.
- To take a gander at what’s coming down the pike, adjust accordingly, and knock business decision after business decision out of the park.
- Remember, what distinguishes these pro forma statements from your standard financials are the adjustments, not the calculations or even the format.
- Building accurate pro forma financials requires an in-depth financial analysis of your present business.
- Pro forma financial statements are valuable tools managers can use to plan for the future, anticipate and control risks and acquire funding for their business.
- Management might not feel that some of these expenses affect cash flow or are not part of normal operating costs, however.
A pro forma financial statement offers projections of what management expects to happen under a particular set of circumstances and assumptions. Standard financial statements are based on a company’s historical performance. In contrast, the purpose of pro forma financial statements is to look to the future or to analyze hypothetical scenarios of what could be.
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. 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. 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. Even public companies are not required to get their pro forma document audited by an independent auditor, according to the SEC. However, to comply with professional auditing standards, the documents can be audited at the request of the company or a third party.
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These are Regulation S-X Article 11, and Regulation S-X 8-05 for smaller companies from 17 CFR 210. Additionally, the SEC may require that pro forma financial statements be submitted when a company is filing for an initial public offering (IPO). This is also true of companies that change tax status from a private, nontaxable company to a taxable C-corporation to file for an IPO.
Since we can’t predict the future, don’t rely solely on pro forma financial statements. Your assumptions could wind up wrong, throwing off your financial projections. Securities and Exchange Commission has guidelines to govern the preparation of pro forma financial statements for public companies.
- A company’s balance sheet shows a company’s financial position and it’s made up of assets, liabilities and equity.
- Here are some ways pro forma financials can benefit your company, no matter which stage of operation you’re at.
- Doing so can allow you to conduct a side-by-side comparison of possible outcomes to determine which is favorable and guide your planning process.
- This pro forma balance sheet can also be used for corporate retail or wholesale businesses.
Pro forma income statements usually project a minimum of three years, whereas regular income statements may just be the year prior or based upon a lender’s request. According to the SEC, when required for public companies, pro forma income statements are required for the fiscal year, but not for interim periods. However, for all regular income statements presented in a filing, there must also be a pro forma statement.
Types of Pro Forma Statements
If, for instance, management is deciding between two separate proposals or business plans, they can use pro forma statements for each scenario and see which might serve their goals and vision best. When your financial statements are put into pro forma financial statements, you adjust material charges, credits, and tax effects to the transactions. In other words, you get an idea of what your financial results would have been if the event had already occurred. These are factually supported by the data from the original financial statements. Pro forma financial statements provide predictions on how the future might unfold for companies you’re investing in.
Pro forma EPS are calculated in the pro forma income statement, but the figure is also used in the pro forma balance sheet and the pro forma cash flow statement, when necessary. According to the SEC, when the dividends from stock exceed or are planned to exceed the current earnings, the EPS must be calculated. The SEC assumes that that proceeds from any additional shares will be used to fund dividends. Statements of cash flow, or cash flow statements, measure the sources of a company’s cash and how it uses that cash over the stated period. 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.
Pro Forma: What It Means and How to Create Pro Forma Financial Statements
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. Simply, a “pro forma invoice” is a “confirmed purchase order” where buyer and supplier agree on top 10 alternatives to xero detail and cost of the product to be shipped to the buyer. A pro forma invoice is generally raised when the seller is ready for dispatching the material but they want to ensure that the payment is being sent before dispatch. And similarly, the customer also wants to know which components are included in the pro forma invoice to avoid disagreements later.
The SEC guides auditors to ensure that they do not take on too much responsibility for the company’s claims. Whether in an assurance that the company is financially sound, also known as a comfort letter, or through a compilation letter, the auditor is only responsible for ensuring the financial statements are prepared correctly. The auditor is not responsible for whether the statements are accurate and honestly prepared, but rather to ensure that there are no material errors, such as mathematical errors, oversights, inadequate disclosures, and clerical mistakes. 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. Public companies that prefer to use a condensed combined balance sheet can use this template to create their own condensed balance sheet. A normal balance sheet covers two years, but it is reasonable for a pro forma balance sheet to cover four years of operations.
Mastering Pro Forma Financial Statements: The Three You Need
They might be overly optimistic or omit important information investors need to know about. Pro forma statements are useful with regard to tracking future financial direction and occurrences, often including some historical numbers to help account for what the projected outcomes should look like. In the event that the projected numbers show that profits are likely to drop, the pro forma statement allows a company to see the need for changes in its operations to prevent decreased profitability. The changes can include cutting costs or increasing the price of goods and services. 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.
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Since pro forma statements deal with potential outcomes, they’re not considered GAAP compliant. This is because GAAP compliant reports must be based on historical information. These are often intended to be preliminary or illustrative financials that do not follow standard accounting practices. Companies use their own discretion in calculating pro forma earnings, including or excluding items depending on what they feel reflects the company’s true performance or future performance.
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. We’re going to take you through the steps necessary to create a basic full-year pro forma projection using an income statement, cash flow statement, and balance sheet. However, we’re lobbing another caveat your way – take our walk-throughs with a grain of salt since they’re only a glimpse into the basic pro forma process. It’s a tool that business owners, decision-makers, stakeholders, investors, creditors, and others use to examine hypothetical conditions. They can look forward or backward, revealing insights that standard financial statements simply cannot provide.
Pro formas can help a company and its lenders determine the most appropriate type of financing. If you are feeling overwhelmed by the idea of tackling this yourself and have a budget, there are professionals, like CFOshare, out there that can help. Certified public accountants are not typically skilled or trained in financial modeling.
That can help you show investors or partners what business finances could look like by the end of the fiscal year. 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.
There are several other types of templates that could be helpful for a business other than the ones already presented here. There are many different periods that could be covered, as well as the different purposes for the pro forma financial statements. A pro forma income statement would show how the company’s revenues and expenses might change and ultimately affect company profits.