What Is Pro Forma?
Pro forma means “for the sake of form” or “as a matter of form." When it appears in financial statements, it indicates that a method of calculating financial results using certain projections or presumptions has been used.
Pro forma financials are not computed using generally accepted accounting principles (GAAP) and usually leave out one-time expenses that are not part of normal company operations, such as restructuring costs following a merger.
Essentially, a pro forma financial statement can exclude anything a company believes obscures the accuracy of its financial outlook and can be a useful piece of information to help assess a company's future prospects.
- Pro forma, Latin for “as a matter of form” or “for the sake of form”, is a method of calculating financial results using certain projections or presumptions.
- Pro forma financials may not be GAAP compliant but can be issued to the public to highlight certain items for potential investors.
- They can also be used internally by management for aiding in business decisions.
- It's illegal for publicly traded companies to mislead investors with pro forma financial results that do not use the most conservative possible estimates of revenue and expense.
What Are the Types of Pro Forma Financial Statements?
Pro forma financial statements are projections of future expenses and revenues, based on a company's past experience and future plans.
Some standard pro format statements include the following:
Pro Forma Budget Documents
A budget anticipates the inflow of projected revenues and the outflow of funds for a defined future period, usually a fiscal year.
A budget is based on certain assumptions about future expenses and revenues. It takes into account past expenses and revenues and factors in the costs of the company's plans for the fiscal year.
Pro Forma Company Income Statements
A pro forma income statement uses the pro forma calculation method, mainly to draw the attention of potential investors to specific numbers when a company issues its quarterly earnings announcement.
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.
In this case, the company is projecting the future, based on its knowledge of past sales and expenses and factoring in expected changes.
Pro Forma Earnings Projections
A company may present a pro forma statement to inform investors about their internal assessment of the financial outcome of a proposed change in the business.
For example, if a company is considering an acquisition or a merger, it may publish a pro format statement of the expected impact of the move on its future earnings and expenses.
Pro Forma Financial Accounting
In financial accounting, a pro forma earnings report excludes unusual or nonrecurring transactions.
These excluded expenses could include declining investment values, restructuring costs, and adjustments made on the company’s balance sheet that fix accounting errors from prior years.
Pro Forma Managerial Accounting
Accountants prepare financial statements in the pro forma method ahead of a proposed transaction such as an acquisition, merger, a change in a company's capital structure, or new capital investment.
These are models that forecast the expected result of the proposed transaction. They focus on estimated net revenues, cash flows, and taxes.
The statements are presented to the company's management to help it make a decision on a proposed action based on its potential benefits and costs.
Limitations of Pro Forma Statements
Investors should be aware that a company’s pro forma financial statements can hold figures or calculations that do not comply with generally accepted accounting principles (GAAP), the set of standards followed by public companies for their financial statements.
In fact, they can differ vastly. Pro forma results may contain adjustments to GAAP numbers in order to highlight important aspects of the company's operating performance.
Pro forma financials in the United States boomed in the late 1990s when dot-com companies 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 (SEC) responded by cautioning that publicly traded companies report and make public U.S. GAAP-based financial results as well. The SEC also clarified that it would deem using pro forma results to grossly misconstrue GAAP-based results and mislead investors fraudulent and punishable by law.
Using pro forma results to grossly misconstrue GAAP-based results and mislead investors is deemed by the U.S. Securities and Exchange Commission (SEC) to be fraudulent and punishable by law.
How to Create a Pro Forma Statement
Basic templates for creating pro forma statements can be found online, or they can be created using a Microsoft Excel spreadsheet to automatically populate and calculate the correct entries based on your inputs.
You can also create a pro format financial statement by hand. The steps are:
- Calculate the estimated revenue projections for your business. This process is called pro forma forecasting. Use realistic market assumptions. Do your research and speak with experts and accountants to determine what a normal annual revenue stream is, as well as asset accumulation assumptions. Your estimates should be on the conservative side.
- Estimate your total liabilities and costs. Liabilities include loans and lines of credit. Costs include lease payments, utilities, employee pay, insurance, licenses, permits, materials, and taxes. Keep your estimates realistic.
- Use the revenue projections from Step 1 and the total costs found in Step 2 to create the first part of your pro format, This part will project your future net income (NI).
- Estimate cash flows. This part of the pro forma statement will identify the net effect on cash if the proposed business change is implemented. Cash flow differs from NI because, under accrual accounting, certain revenues and expenses are recognized prior to or after cash changes hands.
Here’s a historical example of a pro forma income statement, courtesy of Tesla Inc.'s (TSLA) unaudited pro forma condensed and consolidated income statement for the year ended Dec. 31, 2016.
What Is a Pro Forma Financial Statement?
Pro forma financial statements incorporate hypothetical numbers or estimates. They are built into the data to give a picture of a company's profits if certain nonrecurring items are excluded.
These are often intended to be preliminary or illustrative financials that do not follow standard accounting practices. Companies use their own discretion in calculating pro forma earnings, including or excluding items depending on what they feel reflects the company's true performance or future performance.
As pro forma forecasts are hypothetical in nature, they can deviate from actual results, sometimes significantly.
What's the Difference Between Pro Forma and GAAP Financials?
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).
GAAP enforces strict guidelines when companies report earnings, while pro forma figures are better thought of as hypothetical earnings.
For this reason, investors must examine not only the pro forma earnings, but also GAAP earnings, and never mistake one for the other.
What Is a Pro Forma Invoice?
A pro forma invoice is a preliminary bill of sale sent to a buyer in advance of a shipment or delivery of goods. The invoice will typically describe the purchased items and other important information, such as the shipping weight and transport charges.
A pro forma invoice requires only enough information to allow customs officials to determine the duties needed from a general examination of the included goods.
Can You Compare Pro Forma Statements From Different Companies?
Maybe, but it is not advised. Companies' definitions of pro forma vary along with their internal methods for forecasting and making assumptions.
If you don't know how each of the companies defines its pro forma figures, you may be comparing apples to oranges.