A pro forma balance sheet is a financial document that discloses a business’s assets, liabilities, and equity at a specific point in time. This financial statement is not prepared in accordance with Generally Accepted Accounting Standards (GAAP). It is considered more of a balance sheet projection. Pro forma statements are used in the financial planning process to help determine a business’ profitability.
This type of balance sheet can also be used in press releases to clarify a company’s financial situation. Sometimes, it's utilized to soften a company’s loss during a particular time period. Unlike the official balance sheet that is prepared following GAAP standards, the pro forma document excludes unique events and charges.
These events could include costs surrounding an acquisition or merger, or a write down of intangibles, such as depreciation and good will. These items are excluded since they are unique events that will not reoccur. As one-time events, the expenses would have little effect on a company’s ongoing cost structure.
This exclusion of unique events and charges can help provide a clearer view of the company’s long-term financial outlook. This is the information that is important to financial planners. Since pro forma balance sheets are much more flexible than GAAP financial statements, there is also a real opportunity for abuse.
Companies can use the pro forma statement to show that a company is profitable when in reality it is taking a loss. This occurred frequently in the late 1990s during the dot-com boom. The Sarbanes-Oxley Act in 2003 clarified the rules on how a pro forma statement can be disclosed, however, and helps ensure that inaccurate statements do not mislead potential investors.
The US Securities and Exchange Commission (SEC) has also clarified the rules regarding non-GAAP financial statements. These rules are known as Regulation G. Regulation G includes a requirement to disclose and reconcile non-GAAP financial statements, such as pro forma statements, to GAAP financial statements.
The pro forma balance sheet can still be an informative tool when evaluating the profitability of a company, although investors must be careful in their analysis of the information derived from the documents. They must ensure that the differences between the pro forma and GAAP sheets are reasonable. Careful examination of such balance sheets will help investors determine whether these financial statements are accurate or are an attempt to alter the perception of a company’s financial stability.