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- Pro forma income statement allows startups to create a hypothetical projection of your income and expenses.
- The foundation of a pro forma income statement focuses on various assumptions to make accurate quarterly or annual projections of revenue and expenses.
- In creating pro forma income statements, it is advisable to create a revenue model that helps you model out different scenarios with different assumptions. Always sense check assumptions and overall outcomes to make sure your numbers make sense.
- Pro forma income statement is an effective way to get ready for unforeseeable business hurdles, increased taxes, growth plans, and acquisitions.
- A pro forma income statement is an effective way to gain the attention of potential investors, convince them on your growth plans and seek funding.
Today, pro forma financial statements have become essential tools for startup founders. It is an effective way to plan ahead of time and predict, control, and analyze risks associated related to business funds.
Contrary to misguided perception, pro forma financial statements are not reserved for big corporations. In fact, small startups can use pro forma financial statements to understand their current financial value and make calculated future predictions.
Without further ado, let’s take a look at what is a pro forma income statement and how you can get one made for your startup.
What is pro forma income statement?
As a startup founder, you need to think of a pro forma income statement as a hypothetical report on specific scenarios.
Pro forma statements essentially revolve around the “what if” formula for founders of a startup. Whether you “might” lose an account or make an acquisition, pro forma financial statements allow a glimpse into the future.
Ultimately, it involves financial projections and assumptions that allow you to make calculated and logical business decisions. For decades, the proforma income statement has been a useful tool for startup founders, investors, and key decision-makers to examine the future financial health of the business.
Pro forma income statement, however, gains a different meaning under the scope of public companies. In any case, whether you want to purchase new equipment, undertake a new debt, or acquire another establishment, you will need to draft a pro forma income statement to determine the cause-and-effect of the decision.
In comparison, conventional financial statements paint the financial situation of the past, whereas a pro forma financial statement, including an income statement, showcases the future financial health of the startup.
Why do you need a pro forma income statement?
You can use a pro forma income statement to review the projected operational business costs against the current fiscal budget. You can use this benchmark data to figure out whether or not you will expect high expenses in the first quarter as opposed to the second quarter of the year.
You can also use the benchmark data of the pro forma income statement to find out whether or not you will have above-average sales growth in a given year. Similarly, you can use the data to review and decide whether or not you should spend more on your marketing campaigns in the fall months.
When fundraising, proforma statements are useful in giving investors a sense of your revenue growth potential.
Key considerations for a startup
Often, founders are surprised how much pro forma income statement can be advantageous to their startup operations in the foreseeable future. At its core, you have to think of a pro forma income statement as a strategic planning tool to move forward in the right direction.
Pro-forma Income Statement Considerations
When it comes to the proforma income statement, there are several uses, benefits, and subjective considerations you need to know.
Potential Investors Will Likely Ask For This
One of the main reasons to make a pro forma income statement is to capture the attention of potential investors. You can draw the attention of potential investors by announcing your future earnings.
It is an effective way to secure funding and achieve growth in a short time. You can use the same method to secure more funding later on. Pro forma income statement also helps a startup to avail the most suitable financing option from investors.
Ability to Analyze Risks
You can use pro forma income statement projections to establish best and worst case financial scenarios. This helps you realize the range of outcomes your startup can realistically expect in terms of your income.
Positive and ambitious scenarios may paint a rosy picture. On the other hand, you can also get projections that would deplete your startup’s capital and create financial challenges.
Your goal should be to observe and analyze the cost-benefit ratio of each situation and prepare accordingly based on your plan. As you track metrics along the way, you'll be able to course correct and remodel what the future looks like.
For instance, if you want to roll out a new product in the market that would cost you $1 million of equipment and marketing costs, you can add in assumptions on product growth - conservative and ambitious to analyze how the range of outcomes plays on your startups financial health. This will help you figure out the underlying sensitivities (e.g. maybe customer churn is a huge factor that needs preventative measures).
While a pro forma income statement serves as an insightful way to learn about hypothetical financial scenarios, it is vital to take into account that projections are based on educated “assumptions.”
The key is not to confuse assumptions with facts and projected figures with accurate calculations. In fact, take each pro forma income statement figure with a grain of salt. You have to assume that there is a real possibility that the projected figure may not be accurate.
It is better to be cautious and assess the projected pro forma income statement calculations along with the rest of the financial documents to get more accurate and updated projections.
The SEC (Securities and Exchange Commission) has the reputation to consistently update and change its strict rules and regulations on pro forma financial statements. However, SEC rules apply specifically to public companies.
Unlike historical financial statements, you should be aware of the fact that there is no regulation in place on the pro forma income statement and balance sheet. However, to entice investors through optimistic projections, make sure not to stray away from standard accounting practices.
Steps to make a pro forma income statement for a startup
Technically, a pro forma income statement is not so different from a traditional income statement that includes past performance and financial health of the company. But as mentioned earlier, a pro forma income statement projects the future financial health rather than the past.
The projections serve as windows of opportunities for startup founders to increase the production capacity and drive growth in a startup. You can pay close attention to the possible fluctuations in costs in advance.
Once you understand the purpose, importance, and practicality of making pro forma income statements, you can draft them. When you make a pro forma income statement, make sure you are as detailed as possible throughout the process.
Here’s a quick step-by-step approach to create and calculate various aspects of the pro forma income statement:
Step #1 Create baseline
Your first step to producing a pro forma income statement starts by focusing on the current and previous fiscal years. Create a baseline of your income statement as your current state (if you don't change anything) assumptions.
The idea here is to understand how you grow and your baseline revenue and cost growth rates.
Step #2 Add in your assumptions
Your next step is to determine your assumptions for the next 3-5 years. You will do so by looking at two factors:
- Internal factors - Taking your current year (or trailing 12 months) as a baseline, understand current and future drivers of revenue. Do you plan on upping your salesforce? Do you plan on investing in additional marketing channels? How would these drivers impact your revenue? What's the lead time for these factors to show an impact on your revenue? For instance, if you plan to ramp up the sales team, you need to factor in the ramping time before this shows an impact on your revenue.
- External factors - Factor in market, competition, and/or regulatory changes that might impact your product's growth. For instance, GDPR preparedness can impact your timeline on when you would expand to Europe. Alternatively, market reports can help you understand growing trends in customer demand - e.g. the adoption of cloud-based SaaS products over traditional on-premise software can give your company an edge if you play in this field.
It usually helps to build out a revenue model where you can add in your assumptions and sense check numbers to see if they make sense before you plug into your income statement. This way, you can do step #4 (pressure test the numbers and really question your assumptions and your ability to achieve them) before you plug into your financial statements. This will save you time in iterating on your financial statements.
Step #3 Plug into the income statement
As you figure out your growth assumptions, identify the underlying costs and revenue impact it may have on your business. You will need to add both sides into your projected income statement.
Keep in mind the segregation of costs that you'll need to plug in - i.e. cost of sales? salaries of salesforce? marketing expenses? These will have to be rightfully plugged into the right areas.
Here's a good template you can use to format and create your 3-year proforma income statement.
Step #4 Pressure test assumptions
The last step is usually the most important. Your assumptions are only as good as your baseline information that feeds them. Make sure your revenue, expenses, and growth numbers make sense and are error-free. If certain initiatives you had planned haven't given you the returns you expected, it's unlikely they will in the future unless something has changed.
Have multiple team members review your model and your assumptions. Creating different scenarios - conservative, likely, and ambitious can help you understand the range of outcomes and help you set targets and plan for stable, sensible progress.
Here's a simpler example of a pro-forma income statement:
Templates & guides
- Understanding the basics of an income statement
- Understanding the importance of proforma statements
- Downloadable Excel templates for proforma statements
- Revenue models for startups
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Access more guides in our Knowledge Base for Startups
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