Define Pro Forma Income Statement
A pro forma income statement is a projection of future financial performance. Whereas an actual income statement records earnings, revenues and expenses for an elapsed period, a pro forma income statement predicts figures for income for a period in the future. Pro forma income statements are important managerial tools for optimizing operational efficiency. Managers may pinpoint items in the income statement that are below average, and take corrective measures before the projections really occur.
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Maintaining Profitability
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The two main sections in an income statement are revenues and expenses, and most items presented in the report fall into either one of the two sections. The bottom line is the net income, which is the result of subtracting all expenses, taxes and interests from revenues. Subsequently, if a pro forma income statement predicts lower profits, management may use the report to make operational changes to increase profitability, either by increasing profit margin or sales volume. Profit margin may be increased by selling products and services at a higher price, or by cutting down on costs associated with acquiring or manufacturing the product or service.
Comparison
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A pro forma income statement may be used to plan business activities throughout the year, and compare financial performance to past periods, using the figures as benchmarks. Most companies typically go through periods in which sales or costs are higher than other periods, and a pro forma income statement gives management the relevant foresight to plan accordingly for such seasonal fluctuations. Comparing pro forma figures with actual figures enable managers to evaluate performance, and make timely decisions.
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Analysis
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The first step in creating a pro forma income statement is to analyze the income statement for the current year to determine items that may change over the year. The pro forma income statement should ideally be ready as early into the year as possible. After the current year statement is reviewed, each item is estimated, including final sales and expenses. Final figures are estimated considering past record of business, expected growth or decline, and any seasonal fluctuations in sales.
Gross Profit
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The pro forma gross profit is calculated using the pro forma figures for final sales and cost of goods sold (COGS). For example, if the predictions are that sales is going to go up from $10,000 by 5 percent and COGS is going to increase by 3 percent from $4,000, the pro forma gross profit may be calculated by subtracting the new COGS from the new sales. In the example, pro forma gross profit is $6,380 ($10,500 -- $4120), compared to last year's $6,000. Other items in the statement, including salaries and wages, and other expenses are predicted similarly, taking current year figures and calculating predicted change.
Updating
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The final step in creating the pro forma statement is calculating earnings before and after interests and taxes, to give a pro forma figure for profits. It is important to note that pro forma income statements are continuously updated, incorporating any new financial information and aligning figures to match with actual values. Updating monthly or quarterly maintains the pro forma income statement and keeps it as accurate as possible.
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References
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