Pro forma financial statements: How to use them to make smarter business decisions Article

how to create a pro forma income statement

The dot-com bubble, where tech companies enjoyed bloated market valuations before losing it all, proved the harm of pro forma financials. In the early 2000s, Yahoo caught heat after years of releasing pro forma financial statements that downplayed hefty one-time costs from business acquisitions. Small business owners draft pro forma financial statements to quantify the impact of potential business decisions, such as taking out a loan to grow your business. Pro forma financial statements give you and your team something to consider before signing on the dotted line.

how to create a pro forma income statement

If, for example, you want to calculate the impact on the debt-to-equity ratio in future years, you can use the data from pro forma reports. For my purposes here, a pro forma income statement is similar to anhistorical income statement, except it projects the future rather than tracks the past. If the projections predict a downturn in profitability, then you can make operational changes, such asincreasing prices or decreasing costs, before these projections become reality. This portion of the pro forma statement will project your future net income, sale of assets, dividends, issuance of stocks, etc.

Pro Forma Earnings Projections

First, make a typical financial statement, such as a cash flow statement. Then, choose one column to amend with hypothetical figures to match various scenarios. Pro forma financial statements give banks information about your ability how to create a pro forma income statement to make payments while continuing to run your business. “The statements also provide them with the assurance that you understand the operations of your business and what can cause fluctuations in your earnings,” said Taylor.

  • It also advised comparing the pro forma and actual statements to understand them better.
  • If you’re considering a major decision, such as a business merger or a new product launch, creating pro forma statements is important.
  • If material costs increase sharply, or there is a shortage of labor, the cost of sales will increase.
  • Fixed costs stay relatively constant – at least for a while – and are more important in the beginning because they’ll make up a higher percentage of overall costs.
  • Pro-forma financial statements are created for balance sheets, income statements, and statement of cash flows.
  • Over the past couple of years, supply chains have been totally redrawn, and businesses have been forced to evolve how and where they do business.

These financial statements are based on what someone thinks will happen in the future. This is not an indication that what appears on pro forma statements will actually happen. While there is a science in predicting weather trends and how severe it will be, their predictions are not 100%. When trying to make a decision on a company, it is good practice to also analyze the present standard financial statements, as well as pro forma financial statements. This way, one is able to see how successful or not a business actually is. More importantly, a person can compare these statements to get a better idea if the pro forma statements are likely or not likely to come true. As you can see, pro forma financial statements are a great tool that management can use to play out what if scenarios and future projects.

Pro forma Income Statement

One of the many uses of pro forma statements is business and financial planning. This is perhaps the most common reason for creating pro forma statements.

how to create a pro forma income statement

For these purposes, pro forma statements are typically created as a part of a financial forecast in financial accounting. Big corporations who have in-house accountants use pro forma statements for financial modeling and forecasting different scenarios. Pro forma statements don’t need to meet the strictest accounting standards, but must be clearly marked as “pro forma” and can’t be used for things like filing taxes. Using pro forma statements that aren’t marked as such to misrepresent your business to investors, the IRS, or financial institutions can be penalized by the Securities and Exchange Commission). Make sure to use realistic market assumptions to write an accurate pro forma statement. Research and speak to experts to determine what a normal annual revenue stream is, as well as cash flow and asset accumulation. Creating a pro forma statement in Excel from scratch is pretty straightforward.

How do you create a pro forma income statement?

It’s hard to organize your future finances if your current finances aren’t in order. Pro forma income statement allows startups to create a hypothetical projection of your income and expenses.

how to create a pro forma income statement

At some point, we need to hire someone or find a more scalable method. When we know how many units we need to sell, we may get a clearer picture of what else we need to do. For instance, we may now better understand how many customers we need, the number of leads we need from marketing, and maybe even the marketing budget required to achieve these numbers. For instance, if we’re selling products, and each product sells for $100, then our forecasted revenue equates to the sale of 1,200 units, which is easier to digest. If today, our monthly revenue is $100,000, then a 20% increase equates to $120,000 six months from today.

Now the income statement, balance sheet, and other data can be used to create the statement of cash flows. Your pro forma balance sheet shows what you expect your overall financial situation to look like at a specific point in the future. Create one by listing all of the assets you anticipate owning at that point in time.

Before delivering an actual invoice, send a client a pro forma invoice that lists the cost of the goods and services you’re planning to provide. A pro forma invoice isn’t binding; it’s a way to make sure you and the client are on the same page before agreeing to the transaction. The transparency could score you points for customer satisfaction. There are other stable variables that aren’t influenced by sales on the income statement, including operating expenses, depreciation and amortization, and interest expense. The COGS figure does directly vary with sales; if it does not, something is wrong with your numbers. The COGS forecast is the COGS/Sales ratio from several years multiplied by the sales forecast. The final column is your pro forma, which gives you the historical profit and loss.

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