Pro Forma Financial Statements: The Basics

Pro Forma Financial Statements are accounting reports businesses generate to satisfy investor concerns about future revenues and repayment obligations. While they are not required by law most companies publish them alongside their financial reports to provide a better picture of what the company views as its financial health and well-being. Many lenders will require statements like this along with other cash flow projections especially for small business or start-up ventures. This is a brief explanation of what a pro forma financial statement is, why it is important, and what investors and business owners should look for in it.

A Pro Forma Financial Statement is an information tool used by business to provide interested parties an estimate of the financial health of the business for a future period of time.

The function of a pro forma financial statement is to show potential investors a possible financial outcome of a business or business plan. These types of statements have also been used to give an estimated outlook of a new public or recently spun-off business if the business had been a fully functioning independent company. Some larger companies, such as Berkshire Hathaway, publish these statements along with their general accounting statement as a way to show investors how individual divisions are operating independently of other areas of the company.

Some of the many features of a pro forma financial statement include the following:

* Allows you to make educated assumptions for future cash flows, assets and liabilities

* Allows you to create a balance sheet which includes assets, liabilities and shareholder equity

* Allows you to show future results for time periods from months to year or quarterly up to five year forecasts

The effects of having, or not having, a statement can have financial repercussions when a business is attempting to attract investors or obtain financial backing from a lending institution. Both lenders and investors will require this type of statement to show a company's compliance with debt ratios and repayment obligations. Planned transactions such as mergers, acquisitions, capital investments, new debt and new equity can be dependant on the validation of the pro forma statement:

Several considerations should be taken into account when viewing a pro forma financial statement. The use of a public accountant to help review this statement is advisable for someone without much financial background. Consider the realistic expectations of both your investment and the opportunities being presented. If you are asked to prepare a pro forma financial statement, make three; have one for both best case and worst case scenario as well as a statement of realistic expectations. Be sure there are notations to show how the numbers included in the statement were obtained.

Pro forma financial statements can be a good method to foresee the health of a business or any financial issues it may face, if used properly with other accounting and financial statements.