by A pro forma income statement is a document that shows a business’s adjusted income if certain financial inputs were removed. In other words, it’s a way to show what the income of the business would be if some costs were excluded.
Pro-forma earnings most often refer to earnings that exclude certain costs that a company believes result in a distorted picture of its true profitability. Pro-forma earnings are not in compliance with standard GAAP methods and are usually higher than those that comply with GAAP. The term may also refer to projected earnings included as part of an initial public offering or business plan.
Pro-forma earnings in the first sense are sometimes reported by publicly traded companies that want to present a more positive picture of their financial condition to investors. Pro-forma earnings may be either higher or lower than GAAP earnings, but typically they are higher.
Pro-forma earnings may exclude items that don’t normally occur as part of normal operations, such as restructuring costs, asset impairments, and obsolete inventories. By excluding these items, the company hopes to present a clearer picture of its normal profitability.
However, some companies have been known to abuse this practice by repeatedly excluding items that should normally be included. Investors should, therefore, exercise caution when using pro-forma earnings figures in their fundamental analysis. Unlike GAAP earnings, pro-forma earnings do not comply with standardized rules or regulations.
As a result, earnings that are positive in a pro-forma scenario can become negative once GAAP requirements are applied.
Users:
Business owners, accountants, or outside consultants may create pro forma income statements for the following reasons:
- To convince prospective employees of the future health of a business.
- To project the potential income of the business to creditors or investors.
- To inform management of financial scenarios, like large, one-time purchases.
- To help inform decision-making around the acquisition of a company.
Uses of Pro Forma Income Statement
It may be prepared in advance of a transaction to project the future status of the company. For example, if a company is planning to acquire another company, it may prepare a pro forma financial statement to estimate what effect the acquisition would have on its finances.
Forecasting revenues are the most difficult part of any business plan. The assumptions have to be realistic and should be able to support the forecast. It is used to produce the Cash Flow Statements and Balance Sheets, all of which are important components of a business plan.
Pro forma profit and loss statements can also be used to calculate the financial ratios.
For some companies, the pro forma profit and loss statements provide a clear and accurate view of its performance given the nature of their business. Example: telephone and cable companies.
If a company has a one-time expense, it may drastically bring down its net income in that particular year. This cost is irrelevant in subsequent years. Hence companies exclude such costs while making the pro forma profit and loss to give investors and analysts a better picture of the company’s financial position.
Financial statement projections
Financial projections are based on compiling the internal and external accounting data you already use in the day-to-day management of your business. By projecting your revenue and expenses, you can get a more accurate view for how successful your business can be. Creating financial projections is not an easy task but is a very important part of developing a sound strategy. The financials tell you what goals to keep and what to cut.
Projections can also be a guide to help your business grow without running out of cash. To generate and support additional revenues, additional cash is always required. Financial projections help you assess what additional assets are needed to support increased revenue and the potential impact on your balance sheet. The projected financial plan indicates how much additional debt or equity you need to remain solvent and healthy.
Projected financial statements incorporate current trends and expectations to arrive at a financial picture that management believes it can attain as of a future date. At a minimum, projected financial statements will show a summary-level income statement and balance sheet. This information is typically derived from a revenue trend line, as well as expense percentages that are based on the current proportions of expenses to revenues. A better set of projected financial statements will incorporate the following features:
- Expense projections that include step costs for major points at which revenues increase or decline.
- A statement of cash flows.
- Consideration of the pace at which the business can reasonably grow, based on its prior history.
- The ability of the business to attract the funding needed in order to accomplish the financial results stated in the plan.
- Consideration of the corporate bottleneck operation on the ability to grow.
Uses:
- For the first year of business, we include monthly or quarterly financial projections. After the first year is recorded, quarterly or yearly projections will suffice for the next four years.
- Forecast income statements, balance sheets, cash flow statements and capital expenditure budgets for each year you’ve been in business.
- Expert CFOs will write an analysis of your financial information. This analysis can include ratio and trend analysis along with charts and graphs for a visual overview.
- Ensure your projections match funding requests so there are no inconsistencies. We can help to explain any assumptions that accompany your projections.
