Basically a pro forma financial statements (projected financial statements) is a report prepared by the management on the basis of best estimates, assumptions and projections related to an activity or project. Such report is developed to portray, project, analyze and/or plan future performance and events. This is a tool which is created exclusively for the use of management internally. Such report is not meant for investors and creditors unlike financial statements of the enterprise, but used internally by the management to plan future events.
Eying on future progress and prosper, every established business unit plans its activities to be performed in upcoming period of time. These activities are planned in a manner that produce more benefits and good results to the business. These activities generating best outcomes are planned and expected and then the position of cash, assets and other results are looked into and analyzed. For example, management projects activities and event to be performed in future and then see how the cash would look like if those activities and events are happened. Management often tries to work out the results on the basis of assumptions made and desires to see that how the business would look like.
Form the above discussion, it is now easier to understand that pro forma financial statements can also be termed as ‘what if’ financial statements. This address the future position and status of business on the basis of event so envisaged and projected.
Accountants usually prepare Pro forma financial statements are separately but sometimes these reports developed in a set like annual accounts (annual report). Now we would look at each component of pro forma financial statements and would know that why managements need to develop those.
Pro forma Income statement
Pro-forma income statement is of the much importance among all the components of such financial statements. Management usually takes interest to know the volume of expected profits and operating results. Therefore, management develops a pro forma income statement which is sometimes also called projected income statement based on certain assumptions.
For example, management is expecting to start a sale deal with a potential customer. This deal, if happens, shall generate an inflow amounting to $ 2.00 M to the business. Now management shall take the standard income statement and add the anticipated sale of $ 2.00 Million in the sales while preparing pro forma income statement. Relevant expenses shall also be recorded in this income statement in order to have more accurate anticipated results. Once such income statements have developed, the management and even potential investors will look and analyze that how much and to what extent this deal will be valuable and advantageous. After having a draft or anticipated picture of deal being perceived, management decides to embark on or decline the deal/event. You can download proforma income statement template in Ms Excel format.
Pro Forma Balance Sheet
Pro Forma Balance sheet is also very important tool while projecting the events and activities. Projected balance sheet provides information of great importance for both investors and creditors. This is very common practice to develop such balance sheet in order to work out certain ratios and relationship among the contents of such statement. Pro forma balance sheet is used to work out and analyze debt ratios, liquidity ratios and overall level of company’s leverage.
Suppose in previous example, management does not have sufficient resources to meet up the necessary cost of $ 2.00 Million sales. Therefore, creditors will be approached to finance the business. When business takes additional loans from creditors, it will certainly effect the debt equity ratio and liquidity position. Existing creditors would definitely be concerned about new loans obtained. While on the other hand, by observing good results with respect to sales and profits, investors would pay less attention to the level of loans obtained. Because investors are often of the opinion that growth in income/profit outweighs the increase in debts. You can download proforma balance sheet template in Ms Excel format.
Pro Forma Cash Flow Statement
Just like income statement and balance sheet, projected cash flow statement is also prepared to project the level of cash inflows and outflows of future events. Management wants to know that what would happen to the level of cash flows if certain activities being perceived are happened in future. Projected cash flows are developed and a comparison of the same is made with current cash flows. This should keep in mind that project cash flow statement is internally used and does not publish for public reading.
In the above example if management is entered into deal being considered and some additional loans are also obtained, then such deal will affect many items or elements of cash flows. For example anticipated purchases will cause outflow of resources under operating activities. Sales being expected will generate cash inflow under the same activities. Loans being considered to obtain shall be shown as inflow under the financing activities and so on
As we can see that pro forma financial statements or projected financial statements are a potent tool for the management to consult for future projects. These information producing ‘what if’ scenarios are prepared to identify future cash requirements, level of loans to be availed and terms thereof and relevant matters while entering into new deals.