Big corporations who have in-house accountants use pro forma statements for financial modeling and forecasting different scenarios. Start by taking the information from your income statement and using the cash flow statement to determine where your money is going. This statement can be part of a larger cash flow that’s used for financial accounting and decision-making. As we discussed, there are four essential types of pro forma statements, but there are slightly different scenarios for each. You might be wondering how a pro forma balance sheet differs from a budget, as it’s likely tempting to think about the two as the same thing. Although the two documents share commonalities, they are two distinct financial tools that you can use to benefit your business.
They’re a way for you to test out situations you think may happen in the future to help you make business decisions. The P&L and cash flow statements for U.S. companies, at least those that are publicly traded, are laid out in a mandatory quarterly filing to the Securities and Exchange Commission called the Form 10K. Some companies publish similar information in their annual reports to shareholders, but these annual reports are not subject to any sort of regulatory scrutiny, whereas 10K filings can be audited if necessary.
It takes into account past expenses and revenues and factors in the costs of the company’s plans for the fiscal year. With the indirect method, you look at the transactions recorded on your income statement, then reverse some of them in order to see your working capital. You’re selectively backtracking your income statement in order to eliminate transactions that don’t show the movement of cash. Using the direct method, you keep a record of cash as it enters and leaves your business, then use that information at the end of the month to prepare a statement of cash flow. The cash flow statement takes that monthly expense and reverses it—so you see how much cash you have on hand in reality, not how much you’ve spent in theory. They also help make better-informed business decisions and prepare for worst-case scenarios by understanding how certain variables impact the company’s operations.
- Note that our net earnings have increased by more than the 10% of our sales growth!
- These reports provide key stakeholders, investors, and creditors the foresight needed to make decisions and strategically plan.
- This allows you to showcase to partners or investors the potential of the business finances by the end of the fiscal year.
- A pro forma balance sheet is an estimate of your company’s financial position at a specific point in time.
The closer the projection is to the actual numbers reported, the more accurate it is. Further, if a company has a stable order backlog, the pro forma statement of cash flow is more accurate. Finally, and regardless of its relative accuracy, a pro the beginner’s guide to balance sheets forma statement of cash flow forces management to think about the future expected cash flow and whether it is enough. When it comes to accounting, pro forma statements are financial reports for your business based on hypothetical scenarios.
With pro forma statements, businesses can better make assumptions on what decisions are best for the company, such as labor increases, production increases, or even expansion. Traditionally, financial statement analysis is used to better understand a company’s performance over a specified period. While this provides insight into a company’s historical health, creating pro forma financial statements focuses on its future. For this reason, these reports can be leveraged in several ways, including analyzing risk, projecting investments, and showing expected results before the end of a reporting period. A cash flow statement tells you how much cash is entering and leaving your business in a given period.
How to Create A Pro Forma Income Statement
Forecasts that far into the future are often strategic in nature, made more to communicate future plans for the firm than for more detailed decision-making and cash flow planning. Use this break-even analysis template to calculate the number of sales needed to become profitable. Enter the product’s selling price at the top of the template, and then add the fixed and variable costs. Once you enter those values, the built-in formulas will calculate the total variable cost, the contribution margin, and break-even units and sales values. They are useful tools that business owners, investors, creditors, or decision-makers can use to examine different iterations of future events based on certain financial assumptions.
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. A simple way to begin a full financial statement forecast might be to simply use the common-size statements and forecast every item using historical percentages. First, managers must address the cost of an account and determine if it’s a variable or fixed item.
- While it gives you more liquidity now, there are negative reasons you may have that money—for instance, by taking on a large loan to bail out your failing business.
- The limitation of these statements is that they show the business owner nothing more than a prediction.
- When you tap your line of credit, get a loan, or bring on a new investor, you receive cash in your accounts.
- On the P&L statement, its income net of taxes (Line (13) in Table 4.8) would be negative.
- The SEC guides auditors to ensure that they do not take on too much responsibility for the company’s claims.
Risk analysis lets you take the future for a test ride, and try out different outcomes. There are no universal rules that companies must follow when reporting pro forma earnings. This is why it is important for investors to distinguish between pro forma earnings and those reported using generally accepted accounting principles (GAAP). In financial accounting, a pro forma earnings report excludes unusual or nonrecurring transactions. In this case, the company is projecting the future, based on its knowledge of past sales and expenses and factoring in expected changes. For example, a company will report its actual sales and expenses for the quarter that just passed and, in the same chart, will list its projections of these numbers for the current quarter.
Creating a pro forma income statement
The expenses required to support the revenue noted in the order backlog are translated into cash payments for the same period of time. To get sign-off from key stakeholders, win investors, and strategically plan, you need to demonstrate that your ideas make financial sense. As pro forma forecasts are hypothetical in nature, they can deviate from actual results, sometimes significantly.
In our examples below, we’ll use the indirect method of calculating cash flow. However, you’ve already paid cash for the asset you’re depreciating; you record it on a monthly basis in order to see how much it costs you to have the asset each month over the course of its useful life. The first section of the P&L, on lines (1) through (5), outlines the costs and revenues of the power plant project. As a business partner, he helps his clients get a holistic view of their financial health by slowing down to talk about numbers. Then, he breaks down even complex problems into one or two elements to help them break through their barriers of growth.
Pro forma balance sheet
In a sense, pro forma financial statements allow management to A/B test different strategies without any real-world impact. These statements are useful for making estimates and analyzing future risks, but they’re not foolproof. So it’s best to use them in combination with other tools such as balance sheets, income statements, economic audits, and more. Essentially, pro forma financial statements are financial reports based on hypothetical scenarios that utilize assumptions or financial projections. Pro forma financial statements are a great tool for financial management, to assess your financial position in the current year, and for any future time period. If you’re considering a major decision, such as a business merger or a new product launch, creating pro forma statements is important.
Access all Xero features for 30 days, then decide which plan best suits your business. No one knows what the future holds, and many things that can affect the company are out of your control (for example, the economy, a pandemic, war, an industry downturn). Empower your people to go above and beyond with a flexible platform designed to match the needs of your team — and adapt as those needs change. Use this Word template to create your own compilation report, as per the AICPA’s guidance.
The direct method of calculating cash flow
Many items impact the forecast, and they will vary from one organization to another. The key is to do research, gather data, and look around at the market, the economy, the competition, and any other factors that have the potential to impact the future sales, costs, and financial health of the company. Though certainly not an exhaustive list, here are a few examples of items that may impact Clear Lake Sporting Goods. Review the video Business Plan and Pro-Forma Financial Statements to learn about the basics of pro forma financial statements and why they are helpful.
What is a cash flow statement?
Use these free cash flow statement templates to convey how efficiently your company manages the inflow and outflow of money. Use a cash flow statement to analyze the availability of liquid assets and your company’s ability to grow and sustain itself long term. There are many reasons why producing pro forma financial statements could be beneficial for your business. Although pro forma statements have advantages, they have limitations and downsides. After all, the statements are projections, which are essentially guesses about the future. Unfortunately, there are also disadvantages that accompany pro forma financial statements.
Let’s begin with the income statement, using a percent of sales forecast to keep everything straightforward. Start with an income statement from your most recent fiscal year and identify which items you’ll adjust for the projection. Creating pro forma statements is easy with dozens of free and paid tools available online. Here are some ways pro forma financials can benefit your company, no matter which stage of operation you’re at.