Blogs

Your company’s finances play a key role in determining its future. Regardless of the moves you’re looking to make, you’ll want to make sure that the stakeholders involved have enough information on hand to make the best possible decision. While pro forma financial statements aren’t exactly a crystal ball, they’re still a great tool for forecasting and analysis.

What are pro forma financial statements? It’s likely that you’re already familiar with more traditional financial statements compiled in accordance with Generally Accepted Accounting Principles (GAAP). These documents describe financial events that have already occurred in your company’s past, so you’re able to use them when it comes time to file taxes and other official documents.

On the other hand, pro forma financial statements are designed to forecast your company’s financial future. They rely on specific assumptions in order to estimate what your company’s finances may look like over a certain period of time if certain hypotheticals hold true. What if a merger happens? What if this one-time payment doesn’t repeat itself in the future? Ultimately, these are the sorts of questions that pro forma financial statements are designed to answer.

What Does Pro Forma Mean?

To put it simply, pro forma is a Latin term that roughly translates to “as a matter of form” or “for the sake of form.”

A pro forma definition in the financial sense refers to instances where certain assumptions are used to compile financial documents like budgets, income statements, and earnings projections. As long as those hypotheticals hold true, the documents are able to forecast what a company’s financials will look like in the future.

Pro forma financial statements can’t be used to file taxes since they’re based on assumptions about a company’s future performance. Still, they can be a useful way for companies and their stakeholders to get a more accurate sense of their financial standing over a given period of time and therefore make more precise projections about their future. 

Common Types of Pro Forma Financial Statements

The process of creating pro forma financial statements is pretty similar to preparing more traditional financial statements. Whether you’re making a pro forma income statement, balance sheet, or cash flow statement, you’ll want to use the same format and calculations. However, you’ll also want to adjust various line items based on the specific assumptions that you’re using to create the document.

Pro Forma Income Statement

A traditional income statement details a company’s actual sales and earnings over a particular time period. However, companies may also find use in creating pro forma income statements that estimate their future earnings based on their knowledge of past sales as well as expected changes or outcomes related to their particular industry. In particular, these estimates are helpful to share with investors and other key stakeholders in the company.

Pro Forma Balance Sheet

A balance sheet describes a company’s assets and liabilities, as well as the shareholder’s equity. You may find use in a pro forma balance sheet to estimate those figures over a given period of time, especially if your company is planning to make a major purchase in the coming months. Similarly, a pro forma balance sheet can help you evaluate changes in these figures based on scheduled payments on loans. 

Pro Forma Cash Flow Statement

The cash flow statement shows a company’s current cash position, and it’s helpful in getting a sense of a company’s liquidity. You may find use in creating a pro forma version based on expected cash inflows and outflows over a given period, especially if they’re expected to change in a major way. 

Other Pro Forma Options

Depending on your company’s circumstances, there are other pro forma documents that you may wish to create in order to forecast your future. It’s common for businesses to create pro forma earnings projections to inform investors about the expected impact of certain decisions, as well as provide them with a sense of internal expectations for the business. Similarly, pro forma budget documents estimate a business’s expenses and revenues to help make future decisions. 

When Should You Use Pro Forma Financial Statements?

Pro forma statements are most commonly used for forecasting the financial future of your company. They’re designed to better understand and analyze a company’s outlook based on a particular “what-if” scenario: for example, what if there was a merger with another company? What if these costs lowered over time? What if they increased? Based on those calculations, you’re better able to understand and anticipate a company’s results over a particular period of time.

As such, you can use pro forma statements for strategic planning. As an example, let’s consider that you’re choosing between two different scenarios for your company. You might choose to prepare two separate pro forma statements based on those different decisions. Whichever leads to the best outcome would represent the better choice for your company in most scenarios. 

Additionally, pro forma financial projections are helpful when your business is confronted with certain financial anomalies. Consider a large one-time payment—while this would impact your company’s earnings for the relevant quarter, you may be able to assume that it wouldn’t arise again in your company’s future. As such, you can prepare pro forma estimates without that payment to get a better and more accurate understanding of your company’s financial standing in the future. 

When Shouldn’t You Use Pro Forma Financial Statements?

Naturally, there are a few drawbacks involved with the use of pro forma financial statements. The most obvious is that these documents aren’t guaranteed to accurately forecast your company’s financial future. It’s possible that the assumptions you use to compile the data won’t hold true, or that other unforeseen circumstances will impact the actual numbers over the given period of time. 

It’s also worth noting that since the data in these documents isn’t based on historical events, pro forma statements aren’t suitable for use when filing taxes or other official financial information. Given that pro forma documents have a similar look and feel to GAAP-compliant financial statements, it’s important to label them clearly in order to avoid any confusion. 

Unfortunately, many businesses shy away from creating pro forma financial statements. These documents are time-consuming to compile and create, especially with the high levels of accuracy necessary to make them relevant to the decision-making process. Oftentimes, they fall to the wayside in favor of more traditional balance sheets, income statements, and cash flow statements, which leaves businesses with less information about their financial futures. 

Creating Pro Forma Financial Statements With Xledger

Compiling accurate, up-to-date financial statements is a challenging and time-consuming process for many businesses, both large and small. As a result, many businesses simply don’t have the time to create pro forma financial statements in addition to their required quarterly calculations. Unfortunately,  this also means that those businesses aren’t able to take advantage of the benefits of pro forma financial forecasting—which can be especially unfortunate if you’re hoping to plan for what comes next.

Fortunately, Xledger’s cloud accounting software is designed to make financial forecasting efficient and error-free. With Xledger, your business is able to automate up to 75% of its accounting and financial tasks, so you can get real-time insight into your organization’s financial health and outlook. Making better and more informed decisions about your business’s future are only a click away—book a demo to get started today!