Pro forma financial statements are forecasts of the financial position of a company at some defined point in the future. Pro forma financial statements are a critical part of a business plan and therefore are central to the development of a new business. However, pro forma financials are also valuable to existing businesses that want to compare operations from one year to the next. They require a researched and reasoned estimation of future asset acquisition, profits, debts, and cash flows and serve to help shape the plans for growth for the business.
Elements of pro forma financials
Pro forma financial statements should include a balance sheet, an income statement, and a statement of cash flows. A balance sheet in this case will show the projected assets and liabilities of the business. An income statement will show the projected income (or losses) of the business in a given year. A statement of cash flows will show the projected liquidity and operating cash for a business in a given year.
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Reporting of pro forma financials
Pro forma financials are often presented to potential investors in a company in order to show the financial merits of an investment. Similarly, for companies that are publicly listed, pro forma financials must be filed with the Securities Exchange Commission ("SEC"). The SEC also requires publicly traded companies to file pro forma financials anytime there is a significant change in the accounting methodology used by that company.
Adjusting pro formas for acquisitions or disposal of parts of the business
Because one of the main functions of pro forma financials is to compare one year of business experience to another, acquisition or disposal of parts of the business may require adjustments to the pro forma financials to create an "apples to apples" comparison. For example, pro forma financials may need to exclude the addition of a new part of the business in order to compare the operations of the existing business year over year.
Pro forma financials as part of a business start up
A business plan should nearly always include pro forma financials to show the projected viability of a new business. First and foremost, the pro forma financials are valuable for the entrepeneur seeking to start the business in order to determine its viability, the appropriate speed at which to expect the business to grow and to consider alternative plans.
Additionally, for startups that are seeking bank loans, the pro forma financials will be essential in the bank's consideration process.
Accounting standards and pro forma financials
Pro forma financials by their very nature use projects and forecasted figures. Consequently, they are not bound by Generally Accepted Accounting Principles ("GAAP") in the same way as actual financial statements are. This means that there is considerable lee way in the computation of the figures and, in turn, there should be some skepticism by those reviewing pro forma financials.