Uses of a Pro Forma Financial Statement
Pro forma financial statements attempt to indicate what a company's financial position will be on a specific future date. While historical financial statements are based on actual financial data, pro forma statements use a variety of forecasting methods to determine how future changes in sales, expenses and infusions of cash will affect the company's finances. Management and potential investors use pro forma financial statements when making key financial decisions about the company's future.
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Types
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A company's financial statements are made up of three reports---the balance sheet, income statement and cash flow statement. The balance sheet shows everything the company owns and owes at a specific point in time. The income statement, also called the profit and loss (P&L) statement, details all of the revenue and expenses during a given period, and the company's net profit or loss during that time. The cash flow statement shows how cash enters and leaves the company.
Function
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Financial analysts, managers and executives of a business use pro forma financial statements when considering major financial changes such as mergers, taking on new debt, purchasing buildings and equipment and rolling out new products. They are especially valuable for new businesses, which include the information in their business plan for use when seeking new investors or applying for bank financing. Many businesses prepare pro forma financial statements on a regular basis to assist with forecasting and long-range planning.
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Features
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The information on the financial statements can be analyzed by using a variety of financial ratios. A ratio simply indicates the relationship between two numbers, which can be taken from any of the financial statements. There are dozens of financial ratios that are used, and they can help determine the company's profitability, how it manages debt, how much cash the business has or can get quickly and how well it manages inventory, among many other things.
Benefits
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Pro forma financial statements are useful in comparing various scenarios to determine the best option. For example, if a business is trying to decide between paying cash for a particular piece of equipment, as opposed to leasing it or purchasing it with a bank loan, it can prepare three sets of projected financial statements, showing the effect of each choice. From this information, the company can choose the option that would provide the greatest future benefit.
Considerations
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It is important to remember that information in pro forma financial statements is based on various projections, which can change based on a variety of internal and external factors. Also, when looking at the statement, you should make sure that all relevant information is included. For example, if a retailer that does a lot of holiday business is projecting a large sales increase in December, the retailer should also take into consideration the added costs for inventory and staffing, or the projections will be inaccurate.
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