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The same holds true for the process of preparing income statements and cash flow statements. It differs when you begin forecasting various line items and calculating how those projections impact your bottom line. Another limitation of using pro forma balance sheets is the risk of inaccuracies and inconsistencies. Without accurate data and projections, the figures on the pro forma statement can be inaccurate and incomplete, resulting in an inaccurate portrayal of the company’s financial condition. Errors in the data can have significant consequences, so it’s important to be diligent in verifying the accuracy of the information.
- Here are some of the most common situations for using pro forma statements.
- Stable businesses can generally estimate income tax expense as a percentage of income before taxes.
- Now the income statement, balance sheet, and other data can be used to create the statement of cash flows.
- Current assets are heavily used in operations, so it’s fair to assume that these assets will also grow as revenues grow.
- While we can never know what the future holds, we can make some educated forecasts about what it might look like with pro forma income statements.
Another important thing to remember when preparing pro forma statements is to use credible data and not over-rely on hypothetical information, so your estimates are as close to accurate as possible. Taylor suggested starting the process with actual data that has been audited (if you have an auditor), or at a minimum have been validated as accurate. If you plan to seek funding from investors or small business loans, you may be asked for revenue projections. This statement specifically deals with how your company’s results will change if you receive an infusion of capital. You may want to create financial projections for different investment amounts to cover your bases.
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Smaller total assets means returning cash to our investors (by reducing debt or increasing dividend payout) or parking the cash on our balance sheet (in cash or other short term investments). We’re not going to cover exactly how to calculate cash because that’s what the cash flow statement is for, and we’re focusing on the pro forma balance sheet. We want to keep this tutorial simple, so we’ll use the pro forma income statement to help forecast much of the balance sheet. For these purposes, pro forma statements are typically created as a part of a financial forecast in financial accounting. Big corporations who have in-house accountants use pro forma statements for financial modeling and forecasting different scenarios. For example, the business might prepare pro forma financial statements to see the impact of possible litigation on the business.
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Why create pro forma statements?
Adding equity and liabilities together and seeing whether it matches our total assets. Luckily, we already have the existing debt balance, as it’s the most recent value reported by the balance sheet. If we want to be even more “scientific,” we would find something else from the income statement that is a closer reflection of the current liability in question. The potentially tricky thing, in this case, is if we need to deal with existing depreciation. The easiest way to handle depreciation is to look at the income statement for prior periods, which is where depreciation lives. This step wraps up the explanation of our first section, and the only thing left is to add it all together for our total current assets.
The accounts receivable will include any income from this source within the range of your pro-forma sheet, based on your current income and factors such as when accounts receivable bills are usually paid. Here’s a closer look at what pro forma financial statements are, how they’re created, and why they’re a key aspect of financial decision-making. This type of pro forma projection looks at the past financial statements how to prepare a pro forma balance sheet of your business, plus the past financial statements of a business you want to buy. Then it merges them to show what your financials would have looked like if you made a business combination (or merger) earlier. You can use this scenario as a model of what may happen in the future if you buy the other business and restructure now. It may be tempting to think of a pro forma statement as the same as a business budget.
Why do banks require pro forma financial statements?
These are often intended to be preliminary or illustrative financials that do not follow standard accounting practices. Companies use their own discretion in calculating pro forma earnings, including or excluding items depending on what they feel reflects the company’s true performance or future performance. Here’s a historical example of a pro forma income statement, courtesy of Tesla Inc.’s (TSLA) unaudited pro forma condensed and consolidated income statement for the year ended Dec. 31, 2016.
- The critical difference is that pro forma statements are based on “what-if” scenarios, not actual financial results.
- Further, organizations may want to develop their pro forma financial statements while they are doing an annual review of their business plan.
- The business preparing the pro forma financial statements make some presumptions and prepare projected financial statements based on those presumptions.
- Using pro forma results to grossly misconstrue GAAP-based results and mislead investors is deemed by the U.S.
- Sally uses her sales estimate to estimate the dollar amount of inventory at the end of 2021.
Use the templates found here to create your own cash flow statement forecast. Change the dates and time periods to reflect the projection you need to create. A pro forma financial statement leverages hypothetical data or assumptions about future values to project performance over a period that hasn’t yet occurred. Pro forma statements don’t https://personal-accounting.org/total-cost-formula/ need to meet the strictest accounting standards, but must be clearly marked as “pro forma” and can’t be used for things like filing taxes. Using pro forma statements that aren’t marked as such to misrepresent your business to investors, the IRS, or financial institutions can be penalized by the Securities and Exchange Commission).