How to Build a Pro Forma
Pro forma means to provide in advance. In the business world, pro forma financial statements are prepared prior to major business transactions such as restructuring, capital expenditures, new product development and mergers. The purpose of the pro forma statements is to determine the projected financial position of the company post-transaction. The pro forma is meant to simulate the results of the transaction to determine its risk. Although a great deal of speculation goes in the creation of a pro forma, the financial statements should be based on reliable and quantifiable past experiences when possible. Pro forma statements should always be clearly labeled as such.
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Instructions
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You will need to come up with some projected figures for your cash flow, liabilities, assets and sales volumes. These hypothetical numbers need to be based on real-world examples. Start by researching similar companies within your industry in both your geographic area as well as neighboring areas. Draw from past experiences with similar companies within the industry. You will need a projected sales volume and pricing strategy first. You will also need your current assets and projected liabilities for the period covered by the pro forma. Once you have these figures, it is just a matter of creating the financial statements using the hypothetical information.
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Create a cash flow analysis from your projected sales figures and pricing strategy. Start with your beginning cash balance, and add the cash inflow from your projected sales volume. Then you will offset this figure with your projected cash outflows. Be careful not to list future liabilities but only those that will be paid within the period of the cash analysis statement. For instance, if you purchased a truck with a loan, you would include the down payment made within the statement period, not the whole amount owed for the truck.
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Once you have solid cash flow analysis figures, you can begin to construct your balance sheet. The balance sheet will consist of three major sections. The sections are assets, liabilities and owners' equity. The assets section of the balance sheet should match the sum of the liabilities and owners' equity sections. The accounting equation is "assets equal liabilities plus owners' equity." The asset section will contain current and noncurrent assets. Current assets will be used within one year. The noncurrent assets will be held for longer than one year. Next, compile the liabilities section of the balance sheet. List your projected expenses as either current or long-term liabilities. Current liabilities will be paid within one year whereas long-term liabilities will be paid in a period that exceeds one year. The difference between the assets and liabilities equals your owners' equity.
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The income statement depicts a company's earnings or losses over a period of time. When constructing an income statement, it is important to remember to match the transactions with the cost of doing business within the same period of time. The key components of the income statement are sales revenues, minus cost of goods sold, minus operating expenses, minus that period's taxes paid, plus depreciation and minus losses on discontinued items. The bottom line will provide you with the projected profits or losses.
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Your last step will be to provide some overall analysis of the venture. Create a set of key ratio analysis figures. Create a debt-to-equity ratio. This is done by dividing your total liabilities by owners' equity. This determines the projected ability to pay short-term debt. Create a final cash flow statement using the newly created pro forma financial statements. The statement of cash flow will offset your net income with any sales or purchases of assets, dividend activity or bond repayments.
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Tips & Warnings
Pro forma financial statements look at a project or business transaction over a period of time. You can create a set of pro formas for any time period that your transaction requires. However, the longer period of time that the pro formas cover the more speculative the information becomes. The typical time periods for creating a set of statements are one, two or up to five years.
