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Pro forma financial statements provide companies with an estimation of future financial performance. All companies prepare financial statements of some sort, with the most common being the income statement, balance sheet and statement of cash flows. The problem with these statements is that they report past financial history, which may or may not repeat itself. Pro forma financial statements focus on the future, using the past information as a guideline. Having these estimates will help the company budget for future cash expenditures and prepare for strong or weak future profits.
Most companies will use a percentage growth figure as the base when estimating future financial information. For example, owners and managers will study the current economic market or conditions and review historical financial statements with similar sales expectations. This can help the company’s management team determine how much its sales will grow, such as 10 or 15 percent. This growth estimate is then applied to the previous year’s financial statements in order to create the upcoming year’s pro forma financial statements.
The income statement and statement of cash flows are often the two most popular financial statements. Balance sheets contain assets and liabilities of a company; these two categories — primarily those that fall in the long-term asset or liability categories — may not grow significantly during future periods. Short-term assets and liabilities like cash, accounts receivable, inventory, accounts payable or credit lines may be the only accounts that change significantly. Owners and managers may require a small balance sheet pro forma for these accounts to estimate the related expenditures for these accounts.
A simple way to create pro forma financial statements is to apply the growth percentage to previous statements. In many cases, a company’s financial software program will automatically create these statements. An accountant will simply need to enter the expected growth rate and run the statements. Using automated software also allows for multiple pro forma statements that provide estimates on high, average and low growth rates. Each set of statements lets the company then create a budget based on the different scenarios for growth rates.
Publicly held companies often provide pro forma financial statements for investors. These statements generally accompany the forward-looking statements from management. This is a way for owners and managers inform investors on what the company expects to happen in the near future. The company also outlines the safety nets in place to prevent profit loss in case of low growth expectations. This information can help reassure investors that the company will be profitable even during hard times.
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