What is a Pro Forma Income Statement?

Our guide shows you how to read this important report like a professional
Kristen Larson
By Kristen Larson
December 13, 2023

A pro forma income statement is a financial document that predicts the expected financial performance of a business over a specific time period. As such, it’s a useful tool that business owners may use to estimate what their future expenses, revenue, and profits will be.

Pro forma income statements may be used for a variety of purposes including budgeting, financial planning, and forecasting. They may also be used by lenders and investors to determine a company’s financial health and growth potential.

As well as discussing the uses of pro forma income statements, this article will cover pro forma budget documents, pro forma managerial accounting, pro forma invoices, and the advantages and limitations of using pro forma statements in financial reporting. Finally, we will outline the steps involved in creating a pro forma statement.

 

Why Do You Need a Pro Forma Income Statement?

You can use a pro forma income statement to estimate your company's financial performance for a specific period, based on projections and assumptions. Doing so serves multiple purposes, such as evaluating the financial feasibility of a business plan, forecasting future revenues, and assessing the potential impact of operational or financing changes. Additionally, these statements are a valuable resource for businesses seeking financing or making investments.

Pro forma income statements are created by projecting the company's future sales, cost of goods sold, and operating expenses based on market trends, historical data, and other relevant factors. The statement includes line items for revenue, cost of goods sold, operating costs, gross profit, operating income, net income, taxes, and earnings per share. These line items provide valuable insight into a company's profitability and financial position.

This statement can be prepared for any period, such as a fiscal year, quarter, or month. They may also be updated periodically to reflect changes in the company's operations or financial situation.

It is important to note that pro forma statements are only estimations and not actual financial statements for the company. The data presented is based on projections and assumptions and may differ from actual financial results.

Other Pro Forma Statements and Documents

As well as pro forma income statements, there are some other types of pro forma statements to be aware of.

Pro Forma Budget Documents

A pro forma budget document is a financial planning tool that helps businesses estimate future revenues and expenses for informed decision-making. It's typically created during budgeting to allocate funds and evaluate profitability by covering all expected line items such as sales, salaries, rent, utilities, and operating expenses.

Pro Forma Managerial Accounting

A pro forma managerial accounting document provides a detailed view of a company's financial situation, helping businesses to identify areas for improvement and make informed decisions about financial strategies.

It projects expenses, revenue, and profits based on historical data, trends, and other factors, highlighting areas of concern or opportunity. Management can adjust operations or financial strategies based on these projections in order to improve performance.

Pro Forma Financial Accounting

A pro forma financial accounting statement estimates a company's financial future and aids management in decision-making. It may include projected revenues, assets, liabilities, expenses, and equity and can be used with other financial statements like income statements and balance sheets.

These pro forma statements are useful for assessing new business plans, forecasting financial performance, and evaluating operational or financing changes.

Pro Forma Earnings Projections

A pro forma earnings projections statement estimates a company's future earnings over a specific period and aids in planning and decision-making. These statements cover projected revenues, expenses, and earnings per share (EPS) and are created for varying time periods, such as quarterly, annual, or multi-year. They are valuable for assessing the feasibility of new business plans, evaluating the potential impact of operational changes, and forecasting future performance.

Pro Forma Invoice

A pro forma invoice is a preliminary sales document that is issued to customers before the shipment of goods or delivery of services. It provides an overview of the transaction, including details such as the description and quantity of goods, their value, and other pertinent information required by customs officials.

Unlike a commercial invoice, a pro forma invoice does not require immediate payment. Rather, its purpose is to serve as a binding agreement to sell the goods at a specified price. These invoices are commonly used when applying for import licenses, arranging transportation of goods, or securing payment.

 

The Benefits of Pro Forma Statements

Some benefits associated with using pro forma statements are as follows:

  • Pro forma statements offer a useful benefit to businesses by helping with the challenge of forecasting their revenue. These statements provide realistic assumptions which can help companies create accurate projections for their income, cash flow, and balance sheets.
  • Pro forma income statements estimate a company's financial status pre-transaction, like an acquisition's impact.
  • Pro forma profit and loss statements calculate financial ratios and exclude one-time expenses for accuracy.
  • Pro forma statements are particularly useful for companies in the telecom and cable industries to present accurate financial performance.

 

What are the Limitations of Pro Forma Statements?

Investors should be aware that a company’s pro forma statements may contain figures and calculations that do not comply with the Generally Accepted Accounting Principles (or GAAP), the standards that public companies follow for their financial statements.

In fact, pro forma and GAAP statements vary greatly when it comes to their calculations. Pro forma statement results may have adjustments to GAAP numbers so they may highlight important aspects of a company’s operating performance.

It’s important to keep in mind that using a pro forma statement to grossly misconstrue GAAP results and mislead your investors is deemed fraudulent and punishable by law according to the U.S. Securities and Exchange Commission.

Here are some other limitations associated with pro forma statements:

  • Pro forma statements are projections and subject to uncertainty and depend on the underlying assumptions made. Flawed assumptions can result in inaccurate planning and execution.
  • Some pro forma statement formats exclude unsold inventory, indicating inefficient management of production.
  • Pro forma income statements for new businesses may not yield intended outcomes due to insufficient data, particularly if operating for a brief period.
  • Investors and analysts should carefully review pro forma income statements and exercise caution while evaluating what is and isn't included, as not all companies manipulate their earnings.

 

How Do I Create a Pro Forma Statement?

Below is a simple step-by-step guide on how to create and calculate the different aspects of a pro forma income statement. When you make one of these statements, be sure that you use as many details as possible throughout the entire process.

1. Create Your Baseline

The first step is to establish a baseline by analyzing the current and previous fiscal years. This baseline will serve as a reference point for your current financial status and will help you understand your revenue and cost growth rates if you make no changes to your current state assumptions.

2. Add in Assumptions

The next step is to establish your assumptions for the next 3 to 5 years. To do this, you will need to consider your internal and external factors.

Internal Factors

By using your current year, or the last 12 months, as a benchmark, think about the present and future drivers for revenue for your business.

  • Do you plan on increasing your sales efforts or do you want to invest in other marketing channels?
  • How will these changes impact on your company’s revenue?
  • What is the lead time before these factors show an impact on your business revenue?

If you plan to expand your sales team, for instance, you will need to account for the startup time before it actually begins to have an impact on your revenue.

External Factors

Think about any market, competition, and regulatory changes you anticipate within the next few years that will impact on your company’s growth. (Market reports are a helpful resource when considering how industry trends, new technologies and other external factors may impact your revenue.)

It’s helpful to create a revenue model that allows you to input your assumptions and analyze all figures to ensure they are reasonable before you input them in your income statement. 

3. Gather Details From Your Income Statement

While determining your growth assumptions, it's important to also consider the associated costs and revenue impact that it may have on your business. To create an accurate pro forma income statement, you will need to include both sides of the equation.

Make sure to identify and categorize your costs correctly such as cost of sales, salaries of your salesforce, and marketing expenses so that they are placed into the right areas of your projected income statement.

4. Test Your Assumptions

The accuracy of your assumptions depends on the quality of your baseline data. Therefore, ensure that your revenue, expenses, and growth numbers are logical and free of errors. If some of your planned initiatives have not yielded the expected results, it is unlikely that they will in the future unless something changes.

Get multiple team members to review your model and assumptions. Creating various scenarios such as conservative, likely, and ambitious can help you identify the range of possible outcomes, set targets, and plan for stable progress.

 

In Closing

A pro forma income statement can help businesses to estimate their upcoming expenses, revenue, and profits, which can assist in financial planning, budgeting, and forecasting. As a result, it is an essential financial document that can aid business owners in planning and forecasting their financial performance.

Pro forma income statements are also beneficial for investors and lenders that need to determine a company’s financial health and growth potential.

The various types of pro forma statements all have their advantages and disadvantages but it’s important to keep in mind that they are just estimates and their accuracy depends on the correctness of the underlying assumptions. As such, be as thorough as possible and consider all internal and external factors when creating such statements.

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