What is Pro Forma
Pro forma is a Latin term that means “for the sake of form” or “as a matter of form.” In the world of investing, pro forma refers to a method by which firms calculate financial results using certain projections or presumptions.
BREAKING DOWN Pro Forma
Financial statements that use the pro forma calculation method are often designed to draw focus to specific figures when a company issues an earnings announcement and makes it available to the public, particularly potential investors. Companies may also design these pro forma statements to assess the potential value of a proposed change, such as an acquisition or a merger.
Investors should be aware that a company’s pro forma financial statements may hold figures or calculations that are not in compliance with Generally Accepted Accounting Principles. Sometimes, pro forma figures differ vastly from those generated within a GAAP framework, as pro forma results will make adjustments to GAAP numbers to highlight important aspects of the company's operating performance.
Pro Forma in Accounting
In accounting, pro forma refers to a report of the company's earnings that excludes unusual or nonrecurring transactions. Excluded expenses could be declining investment values, restructuring costs, and adjustments made on the company’s balance sheet that fix faulty accounting practices from other years.
Pro Forma in Business
In a business sense, companies make financial statements prepared with the pro forma method ahead of a planned transaction such as an acquisition, merger, change in capital structure, or a new capital investment. These models forecast the expected result of the transaction, with emphasis placed on estimated net revenues, cash flows, and taxes. Pro forma statements, therefore, show the projected status of a company based on current financial statements.
How to Create a Pro Forma Income Statement
Today, there are several places where you can find a boilerplate template for generating a pro forma financial statement, such as the income statement, including Excel spreadsheets that will automatically populate and calculate the correct entries based on your inputs. Still, you may want to know how to create a pro forma income statement by hand.
- Step 1: Calculate the estimated revenue projections for your business (this is called pro forma forecasting). Use realistic market assumptions and not just numbers that make you or your investors feel optimistic. Do your research and speak with experts and accountants to determine what a normal annual revenue stream is, as well as cash flow and asset accumulation assumptions. Your estimates should be conservative.
- Step 2: Estimate your total liabilities and costs. Your liabilities are loans and lines of credit. Your costs will include items such as your lease, utilities, employee pay, insurance, licenses, permits, materials, taxes, etc. To create the first part of your pro forma, you’ll use the revenue projections from Step 1 and the total liabilities and costs found here. Put in a great deal of thought into each expense and keep your estimates realistic.
- Step 3: Estimate the cash flows. This portion of the pro forma statement will project your future net income (NI), sale of assets, dividends, issuance of stocks, and so on.
The Popularity of Pro Forma
Pro forma results in the United States boomed in the late 1990s surrounding dot-com companies that used the method to make losses appear like profits or, at a minimum, to reveal much greater gains than indicated through U.S. GAAP accounting methods. The U.S. Securities and Exchange Commission responded by firmly requiring publicly traded companies in the country to report and make public U.S. GAAP-based financial results. The SEC also clarified that it would deem using pro forma results to lie about or grossly misconstrue GAAP-based results fraudulent and punishable by law if they misled investors.