Pro forma financial statements are financial projections based on managers’ estimation of how much money a new venture can bring. Pro forma statement is an important part of a business plan -- no sponsor will consider investing in your business without first having a look at it. Because pro forma statements are estimations, they will never be completely correct. However, it is possible to write very realistic pro forma statements if managers follow the steps below.
- Skill level:
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Research businesses similar to the one you want to start. Because you do not have a history of past performance to base your projections on, studying examples of similar companies may be needed to make realistic assumptions. Finding real company financial statements should not be a problem because many companies post them on their websites for the general public.
Write an income statement. Income statement, also called profit and loss statement, is calculated by subtracting expenses from revenues. Estimate how much you will sell each month and how much it will cost you to produce that quantity. Include fixed expenses such as rent of facilities, employee salaries and machinery. See if these calculations leave you with any profit. No profit is a bad signal that may require major changes in your business plan.
Create a cash flow statement. Cash flow statement involves calculation of incoming and outgoing cash flows. Start-up costs, other initial investments, loans and money earned from sales are included in incoming cash flows. Cash spent on operational and production needs is part of outgoing cash flow. Subtract outgoing cash flow from incoming cash flow. If the sum is less than 0, there is a problem with your business plan.
Prepare a balance sheet. Balance sheet is a list of the company’s assets and its liabilities. Assets are the property, inventory and cash available to the company. Liabilities include loans, debt and accounts payable. Remember that a balance sheet is a snapshot of your company at a given time so it has to be dated properly. A balance sheet consists of the following elements: current assets -- revenue from sales in the next year, accounts receivable, inventory; long-term assets -- value of the assets you are not going to sell in the coming year -- property, equipment and vehicles; current liabilities -- accounts payable in the next year; long term liabilities that are not due in the next year; owners’ equity -- includes the amount each shareholder will get if all assets are sold.
Tips and warnings
- While the main purpose of a pro forma statement is to attract investments, do not forget that it can also help you assess how good your business idea is. If you see that the new business will not bring money, abandon your idea.
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- Community Futures Centre West: Business planning: Pro forma financial statements
- Hong Kong Institute of Certified Public Accountants: Preparation of pro forma financial information for inclusion in investment circulars; 2006
- Owen Graduate School of Management: A note on the preparation of pro forma financial statements; Germain Boer; 2001