Pro Forma Financial StatementsExplained with Advantages & Disadvantages

Written By:
Adiste Mae

A company’s financial statements are more than just numbers – they tell a story.

They provide a general indication of what the company is and what it aspires to be.

The most common financial statements that a company has are the Income Statement, Balance Sheet, Statement of Cash Flows, and Statement of Changes in Equity.

These financial statements are very helpful, but they only refer to the historical financial data of the company and therefore lack the necessary information to plan for the future. 

For this reason, Pro Forma Financial Statements are prepared so that companies can prepare forecasts and projections that will better aid management in their decision-making. 

What are Pro Forma Financial Statements?

Pro Forma financial statements are forecasted financial statements based on assumptions and hypothetical data.

They are used to provide outside users with these financial statements to have an idea of what the business will look like over a certain period of time in the future if they take a specific course of action.  

The most commonly used Pro Forma Statements are the Income Statement, Balance Sheet, and Statement of Cash Flow.

Users of Financial Statements such as investors, creditors, employees, business owners, and key decision-makers,  do not only rely on historical data but also projected financial statements of the company to help them make a better judgment in their decision-making process. 

How are Pro Forma Financial Statements Used? 

Pro Forma Financial Statements prove to be most useful when it comes to making important financial decisions and strategic planning.

Financial analysis helps with the projection of future results, helping decision-makers be well guided to proceed to a certain course of action.

Through the projected financials, companies are able to analyze risk, make projections of the results of the current accounting period, and also foresee investment opportunities. 

When presented with different investments scenarios, the pro forma financial statement can be used to make projections based on these scenarios. 

Creating Pro Forma Financial Statements

The preparation of Pro Forma Financial Statements is the same as preparing the regular statements.

However, there are certain methods used when preparing the projections.

For example, if a company wishes to buy new machinery, it would have to do that through financing. 

Pro Forma Income Statement

With the additional machinery, the company would have to make an analysis of how it will affect the profits of the company.

Should the company proceed to purchase the machinery, its effect on the revenues needs to be considered. 

Pro Forma Balance Sheet

If a piece of new machinery is going to be purchased, there will be an increase in the Property, Plant and Equipment of the company.

If this purchase is going to be financed through debt, the liability account will increase.

In the same way, should it be paid by cash, the cash balance will decrease. 

Pro Forma Statement of Cash Flows 

Financing will mean a series of payments that a company will have to commit to until the debt is fully paid.

Through the Cash Flow Statement, the business will be able to project the amount of cash outflow for the payments towards financing, and inflows from the increase in sales brought about by the addition of a piece of machinery. 

Beyond the Numbers

Those who interpret Pro Forma Financial Statements should be cautious in depending on the statements to make financial decisions for they are only going to happen should all the assumptions made by the company hold true.

However, they provide stakeholders reports that will influence the decisions that they have to make and strategically plan for the future.