Pro Forma Financial Statements
In business, the term “pro forma” is used to describe some kind of information, usually financial statements, where the financial statements are on an “as if” basis; that is, as if something in particular had happened.
Pro forma financial statements prepared for internal use in the planning process, are financial statements containing projected amounts that are expected if a particular course of action is followed.
Pro forma financial statements are used to see what the financial statements of the firm will look like if something under consideration or forecasted actually happens.
Pro forma financial statements are often used to evaluate the effects on the company’s finances if a particular sales forecast is realized, although they can be used for other “what if” scenarios as well.
By analyzing pro forma statements, managers can project what the company’s cash position will be, whether it will need to borrow, whether it will be able to make its scheduled loan payments, whether it will remain in compliance with debt covenants, and so forth.
Pro forma financial statements are not the same thing as the master budget financial statements, although one or several versions of pro forma financial statements may be prepared as a part of the formal planning process that will eventually result in the master budget.
Pro forma statements may be prepared after the formal budget for the year has been adopted, if the company is considering an activity that was not foreseen before the formal budget was adopted.
Pro forma financial statements are not prepared individually for each department and then consolidated into budgeted statements for the whole company the way budgeted financial statements are. They may be prepared for the whole company or for only one department or division.
Pro forma financial statements include a pro forma income statement, a pro forma statement of financial position (balance sheet), and a pro forma statement of cash flows. In other words, they are a complete set of financial statements using projected amounts that tie together the same way the amounts in the actual financial statements do.
The term “pro forma” is sometimes used to refer to the master budget financial statements as well, but its use in that context is an inappropriate use of the term.
Pro forma financial statements are used internally for five general purposes:
- A pro forma financial statement is used to compare the company’s anticipated performance with its target performance and with investor expectations.
- Pro forma statements are used for “what if” analysis to forecast the effect of a proposed change.
For example, if the company is contemplating a price increase that it anticipates will reduce the level of demand for its product, it will prepare a pro forma financial statement to determine the result on the financial statements if the price increase is put into effect. - They are used to determine in advance what the company’s future financing needs will be.
- Various cash flow projections and sets of pro forma statements may be prepared using different assumptions for different operating plans. They are used to forecast the capital requirements of the plans in order to select the plan that maximizes shareholder value.
- Pro forma financial statements are used to determine whether the company will be able to remain in compliance with the required covenants on its long-term debt.
Pro forma financial statements may also be prepared by someone outside the company. For example : an investor or security analyst might prepare pro forma financial statements to forecast a company’s future earnings, cash flows, and stock price. However, in this text “pro forma” refers to top-level planning that takes place within organizations.