What are Pro Forma Financial Statements?

by Adarsh Raj Bhatt in
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Image credit: Unsplash

Key takeaways

  • Financial reports that are drafted on the basis of developments that might take place in the future or have taken place in the past are known as pro forma financial statements.
  • Two very specific examples of pro forma financial statements are full-year pro forma projection and investment pro forma projection.
  • Pro forma balance sheets use existing financial statements as a basis to outline the estimated condition of the startup in the future after an intended transaction has occurred. 
  • Pro forma income, often seen in the form of a pro forma income statement, presents the income of the startup in an adjusted form where specific costs are excluded.
  • A pro forma cash flow statement is a common accounting procedure where a voluntary cash flow statement is reported for showing financial projections. It is the estimated amount of cash flow predicted for a given time in the future.
  • Pro forma financial statements have become instrumental tools for founders. They serve as efficient mechanisms to plan for the future and foresee, manage, minimize, and evaluate the risks related to the startup's capital.

What are pro forma financial statements?

Financial reports that are drafted on the basis of developments that might take place in the future or have taken place in the past are known as pro forma financial statements. These financial reports are often issued for the benefit of those who are not inside the startup to give them insight into the startup's growth and trajectory. The reports could be included in a proposal for fundraising or loans. A budget can be seen as a different kind of pro forma financial statement because it reflects the estimated outcomes of a startup during a particular time in the future. These projections are based on specific assumptions or hypothetical assumptions about future events. 

Some common questions on the minds of founders are:

What is a pro forma balance sheet?

Pro forma balance sheets use existing financial statements as a basis to outline the financial position of the startup in the future after an intended transaction has occurred. 

What is pro forma income?

Pro forma income, often seen in the form of a pro forma income statement, presents the income of the startup in an adjusted form where specific costs are excluded. As a result, a pro forma income statement presents what the startup's income would have been if specific financial inputs had been excluded. 

What is a pro forma cash flow statement?

A pro forma cash flow statement is a common accounting procedure where a voluntary cash flow statement is reported for showing financial projections. It is considered to be the estimated amount of cash flow predicted for a given time in the future.

Why are pro forma financial statements relevant to startup founders?

Pro forma financial statements have become instrumental tools for founders. They serve as efficient tools to plan for the future and foresee, manage, minimize, and evaluate the risks related to the startup's capital. The mindset that these statements are reserved for large enterprises is false. The reality is that they can be used by founders to better understand their startup's existing financial value and produce more accurate estimates for the future.

Since pro forma financial statements are such a crucial component of the planning process for getting a new startup off the ground, they can help mitigate the risks. Since lenders and investors consider the data in pro forma financial statements carefully, they also act as a powerful means of persuasion when looking for loans or investments. With all that said, pro forma financial statements should be founded on factual and credible data so that they can present the correct forecast of a startup’s profits and monetary requirements. After the startup has been launched, the founder(s) must revise these projections every month and every year.

In order to prepare conventional statements, a startup needs a robust financial track record. Since most startups don’t have that kind of track record, pro forma financial statements become especially useful for them. 

Without having pro forma financial statements, the chances of a startup making it are adversely affected. This is because these statements help founders to back up their vision and ground their ideas in financial assumptions and projections that seem realistic. It becomes extremely important to get this right considering how, statistically speaking, the odds of raising the required capital (through investors) are stacked heavily against founders. Investors generally always have tight purse strings when it comes to deciding whether to pour capital into early-stage startups. And the startups that do manage to get funding are required by investors to send in pro forma financial statements as well as comprehensive business plans. Pro forma financial statements give investors a timeline for when they should anticipate their investment to yield a return. 

The following are some examples of pro forma financial statements: 

  • Full-year pro forma projection: This refers to a set of full-year pro forma financial statements, which comprises the year-to-date outcomes of the startup along with projections for the rest of the year. This helps keep internal (founders and team members) and external (investors and/or lenders) stakeholders updated on projected outcomes.
  • Investment pro forma projection: This approach is used by startups when they are looking to raise capital and wish to demonstrate to investors how the outcomes of the startup might be affected by a specific amount of capital investment. This strategy leads to distinct groups of pro forma financial statements created based on the amount of each loan.

How to create a pro forma balance sheet?

A pro forma balance sheet systematically organizes financial projections in a tabular form and assists a startup in better managing its assets to produce improved future results. It minimizes many kinds of nasty surprises related to bill payments, investor returns, and inventory management. 

The following are the steps for creating a pro forma balance sheet:

Current assets

First, the pro forma balance sheet will need to include short-term assets like cash and accounts receivable. The latter should cover incomes that fall in the range of this financial statement. The basis of accounts receivable should include current income and the typical timeline that’s followed for the payment of accounts receivable. For instance, the accounts receivable in a pro forma balance sheet for December should consider income to be received by the end of December if the money is expected in a month’s time.   

Fixed assets

The pro forma balance sheet will need to incorporate fixed or long-term assets to include in the total amount. Examples of long-term assets are property, plant, and equipment (PPE) such as land, automobiles, buildings, etc. 

Individual asset value would need to be calculated before calculating the sum total (long-term) asset value. For example, considering that land does not depreciate over time, the value of land would be the same as its initial purchase price. On the other hand, buildings and vehicles do experience depreciation, so their value would need to be calculated by deducting the current depreciation from the original purchase price. To calculate the current depreciation, you will need to know what the official depreciation value of the asset is. According to the IRS, for a building, it is approximately 40 years. So, the original purchase price of the building would need to be divided by 40 before being multiplied by the number of years that you’ve used the building for. You would arrive at the current value of depreciation of the building, which would then need to be deducted from the initial purchase price to give you the building’s asset value. 

The same process can be used to calculate the asset value of vehicles, except for substituting the depreciation value of the building with that of the vehicle. Generally, the life span of vehicles is about 8 years.

Pro-forma total assets

Next, note down your total asset value. The value of pro-forma total assets is equal to the sum total of the values of short-term assets and long-term assets calculated in the two steps before this. 

Total liabilities

Liabilities comprise expenses that are due to be incurred in the range of the pro-forma balance sheet. Examples of such expenses could be:

  • Accounts payable
  • Wages to be paid
  • Loan payments
  • Mortgage payments

Going back to the example of a pro forma balance sheet being prepared for December, such a financial statement would need to include any and all amounts of money that your startup owes in that month such as money due to be paid to consultants, contractors, team members, laborers, loan payments, mortgage payments, etc. 

After the values of all these liabilities have been accounted for, they should be totaled to give the final value of the total liabilities.

Tabulating 

Finally, organize all the data and deduct total liabilities from total assets to find out if your assets are sufficient for your startup to sustain its operations or if they are insufficient -- in which case, you might need to borrow loans or/and reduce expenditures.

Templates & useful resources

Templates for Pro Forma Financial Statements

Pro Forma Balance Sheet Template

Pro forma Income Statement Template

Pro forma cash flow template

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