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Pro forma profit and loss is a projection of a company's net income for a period of time in the future. This information is usually found on a profit and loss statement, which is also known as an income statement, and includes a company's projections for future revenue, expenses, and income. Projecting pro forma profit and loss is important for a company in that it allows it to budget for the upcoming period of time and see where adjustments have to be made in their operations. One method for projecting these figures is to look at a current statement, decide if there are changes to certain items in the offing, and adjust the other items to correspond with these changes.
A company has several reasons why it must prepare a profit and loss statement. It is generally required of large, public companies, so that investors, financial regulators, and stockholders may have access to a company's pertinent information. An income statement also serves a purpose for the company in that it shows areas of the business that might need improvement. Preparing a pro forma profit and loss statement is useful so that a company can see where it is headed in the future.
It is important to understand that the information found on the statement may not actually be realized. Unlike current income statements, which must be based on actual financial information, pro forma numbers are mere estimates. Still, it is important that a company get as close as possible when projecting future numbers.
When preparing a pro forma profit and loss statement, company management should include all of the items that affect net income. This means that revenue from sales should be estimated first. Following that, projected expenses, which include cost of goods sold, operational and administrative expenses, and interest and tax charges, should be compiled. Subtracting projected expenses from projected revenue yields an estimation of the company's net income for the period being studied, which is usually the upcoming year or a year in the near future.
There are several different methods by which a company can project pro forma profit and loss. The most common way is to look at a current statement and project forward based on expected increases and decreases. For example, if a company's sales are expected to rise by 10 percent, the current revenue should be raised by the corresponding amount in the pro forma statement. Companies must be as realistic as possible with their estimates, since these estimates often provide the basis for budgeting and decision-making in the years to come.
Here's where companies have to be careful -- overly optimistic projections can be very dangerous when forecasting future budgets. And there are directors who tend to be overly optimistic when projecting both increases and decreases in revenue.
If you have too many of these "happy, happy, joy, joy" types in a company, they can drag the business into trouble in a hurry. Optimism is good, but realism is almost always better.
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