“What if” is one of those key phrases that business owners think about virtually all the time.
What if we made an acquisition? What if we lose that account?
Pro forma financial statements are essentially “what-if” generators, giving you the ability to work through different hypothetical scenarios and explore their potential impact on your business.
A pro forma financial statement generally refers to a forward-looking financial projection, modeling results based on certain identified assumptions. Typical accounting financial statements include an income statement, balance sheet, and cash flow statement, and any of those statements can be shown as a pro forma projection or model.
A pro forma statement is often created at the time of a company merger or acquisition, creation of a new startup company, or making a capital investment such as equipment or real estate property. A company or organization’s annual budget is a type of pro forma, as it is a projected result based on assumptions. A company could also create multiple pro forma financial statements to compare results under different scenarios when making a decision. The pro forma shows what the financial results would be under the new scenario, and focuses on revenue, expenses, and overall cash flow.
Pro formas may be used by potential investors who are evaluating the potential return of a project, banks in making commercial lending decisions, and are helpful to company management when comparing actual results to what was projected for the same time period. They also can be used after the time of a company merger or acquisition, to show what the income statement would have been if the acquisition or merger had been done prior to the time period being shown. If the company issuing the statement is a publicly-traded company, the Securities and Exchange Commission (SEC) has a specific set of rules and requirements surrounding pro forma financials.
A real estate pro forma projects a property’s future income and expense. A pro forma is typically based on known facts as well as certain educated assumptions about items; for example, interest rates over a period of time, or the cost to insure a similar property. A real estate pro forma shows the purchase price of a property, anticipated rental income as well as maintenance, property management, taxes, insurance, interest, and other property expenses. Modeling the result of those figures provides a forecasted cash flow and overall return on investment over time.
Overall, people who use a pro forma financial statement should understand that the statement is not showing past or guaranteed results. They should understand the assumptions that are made in the statement. If an entrepreneur is creating pro forma financials to request credit from a bank, it’s a good idea to review with an accountant.