About Pro Forma Financial Statements
Pro forma financial statements are an asset to a company in the 21st century. They provide business leaders with necessary projections of the financial health and future of an organization. There are a variety of elements to a pro forma financial statement, all of them substantially informing management and the board about the future of the company.
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Function
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In advance of a planned business transaction, such as an acquisition, merger or capital investment, a pro forma financial statement is prepared. The pro forma predicts the results of the event by projecting cash flow, net revenue and taxes. When a company's financial condition is affected by a transaction of material impact, a pro forma financial statement is produced for managerial and board review. A business plan is often also included, especially for incidents that portend a change in capital structure.
Significance
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Investors and lenders often require pro forma financial statements to analyze the impact of their transaction. The statement will give them information about the credit risk of the company, defining the potential losses that could accumulate due to debtor's non-payment on a loan or a line of credit. This could involve either loss of the principal or interest.
A pro forma financial statement also predicts the debt-to-equity ratio and informs a potential investor of a company's financial leverage and any accounts payable that may exist.
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Features
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In addition to being used by established firms, pro forma financial statements are also created at the founding of a new corporation. The statement will give prospective investors insight into how the company envisions itself operating, and what plans are in place for revenue, taxes and cash flow. Pro forma figures are generally clearly defined in this initial statement, to allow the corporation to analyze differences between its performance and its projections.
Types
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Pro forma financial statements offer short- and long-term overviews of the financial well-being of a business. This is segmented into four sections, each with its own purpose:
The balance sheet shows the condition of the finances within an organization. It presents company assets, liabilities and equity.
The income statement, also known as a Profit and Loss statement, analyzes the company's income, expenses and profits for a certain time period.
The statement of cash flows reports on a company's operating, investing and financing activities.
The statement of retained earnings offers an explanation regarding a change in the company's earnings.
Considerations
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Large corporations use pro forma financial statements to a great degree; however, these statements can end up being very complex and extensive. As such, a series of notes is added to the financial statement, to be analyzed by management and the board. These notes will further detail important facts about the balance sheets, income statement and cash-flow statement, allowing management and the board to discuss the results in greater detail. Notes are an important part of any pro forma financial statement.
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