A pro forma income statement is a financial report that projects a company’s future income, expenses, and profitability based on specific assumptions or hypothetical scenarios. Unlike traditional income statements, which reflect historical data, pro forma statements provide a forward-looking view, helping businesses evaluate the potential impact of decisions such as mergers, product launches, or expansion.
Understanding how to create and analyze pro forma income statements is crucial for making informed strategic decisions and managing financial risk effectively. Keep reading to learn more on what pro forma income statements are, pros and cons of using them, how to create them, and more.
Key Points
• Pro forma income statements project future revenues, expenses, and profits based on hypothetical scenarios or planned events.
• These statements help businesses evaluate the financial impact of strategic decisions, such as cost-cutting measures or new investments.
• The projections are based on assumptions about sales, costs, and market conditions, making it flexible for different scenarios.
• Pros of pro forma income statements include helping with financial planning and strategy and showing what-if scenarios for your business.
• Pro forma statements are often used to attract investors by showing potential growth and profitability under favorable conditions.
What Are Pro Forma Income Statements?
Before we look at your pro forma income statement definition, let’s first look at what a traditional income statement is. An income statement shows a company’s income and expenses over a given period. It’s used to determine whether a company was profitable or not over that time.
The problem is: not every period is the rule. There are always exceptions, like when you purchase another company or have to liquidate a large amount of inventory. In these exceptions, a traditional income statement won’t accurately reflect the financial health of your business. That’s where a pro forma income statement is more useful.
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How Do Pro Forma Income Statements Work?
Just like you would with a traditional income statement, with a pro forma statement, you’ll include both the income and expenses of your business. The caveat is that you factor in whatever scenario you’ve got that will skew the income statement. In our example above, you might remove the investment cost of the business you acquired, since that large investment would make it look like your business operated at a loss.
Pro forma income statements can also be used to forecast potential revenues based on a particular scenario. Let’s say you acquire that business, which will create a drop in revenues in the short term. This might also, however, create a boost in revenues down the road, and you can calculate this potential increase in revenues in your pro forma statement.
It’s important to note that pro forma income statements aren’t approved for Generally Accepted Accounting Principles and should only be used internally to better understand income and expenses over a period with unusual activity.
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When Do Businesses Use Pro Forma Income Statements?
Under normal conditions where you have no unusual expenses or revenues, you would use a traditional income statement. But if something out of the ordinary occurs, such as purchasing another business or upgrading equipment, or you need to liquidate inventory that hasn’t sold, it might be better to use a pro forma income statement.
Keep in mind that sometimes when you use a pro forma statement, you’re basing your numbers on a hypothetical situation. By removing the costs to manufacture a product you might decide to stop selling, you’re making assumptions that you’ll sell all the assets involved with that previous product and get numbers back up to what they were for revenues. Because this is a bit of speculation, you can’t share this pro forma statement with investors or shareholders. It’s more used internally to understand how your finances would look if a certain situation occurred.
Which Types of Businesses Use Pro Forma Income Statements?
Any business that has unusual activity over a period can choose to use a pro forma income statement. If you’re considering applying for a small business loan, it can be helpful to know what your finances would look like under those scenarios we discussed so you can determine how much you need to borrow to have available working capital.
There are many types of business loans available to businesses that might need a little cash to get over the hump after a large investment, like acquiring another company, including equipment financing loans.
How to Create Pro Forma Income Statements
On the surface, a pro forma income statement looks like a traditional income statement. It includes both revenues and expenses. The difference is that it also factors in the scenario you’re calculating for.
Some pro forma income statement examples might factor in:
• A large investment for acquiring a business or purchasing high-cost equipment
• A forecast for a sudden increase in revenues due to a new client
• The loss of revenue from stopping a product line and liquidating assets
You can create as many pro forma income statements as you like, so if there are different scenarios you’d like to explore, such as different price points for products, these statements can give you a sense of what each potential possibility would bring.
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Pros and Cons of Using Pro Forma Income Statements
So is it worth it to use pro forma income statements? Here are the benefits and drawbacks.
| Pros | Cons |
|---|---|
| Show you a what-if scenario | May not accurately depict your company’s financial situation |
| Can help with financial strategy and planning | Not GAAP compliant |
Because the pro forma income statement is based on a possible scenario, you can use it to make informed financial decisions for your business, such as whether or not to take out a business expansion loan. Just be aware that it won’t accurately depict what’s going on with your company, but rather a possibility. And you won’t be able to use these statements anywhere you’re required to use GAAP reports.
Pro Forma Income Statement vs. Income Statement
As mentioned, there are similarities and differences between traditional income statements and pro forma statements.
| Traditional Income Statement | Pro Forma Income Statement |
|---|---|
| Calculates based on actual numbers | Considers scenarios and possibilities |
| Based on past financial activity | Projections for future based on past |
A traditional income statement uses actual numbers for profit and loss based on what has happened in the past. A pro forma income statement looks at different possibilities based on certain scenarios and may use past data to create future projections for profit and loss.
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The Takeaway
If your company has unusual activity coming up that can significantly alter a traditional income statement, consider using a pro forma statement to get a better sense of your profits and losses. Likewise, if you’re considering a certain action, such as buying another company, a pro forma income statement can help you make an informed decision.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
What’s the difference between a pro forma income statement and an income statement?
A traditional income statement is based on actual numbers, while a pro forma income statement may use projected or hypothetical numbers based on certain scenarios.
What should be included in a pro forma income statement?
A pro forma income statement includes projected revenues, cost of goods sold (COGS), operating expenses, and taxes. It also forecasts gross profit, operating income, and net income based on assumptions about future performance.
What items are excluded from a pro forma income statement?
A pro forma income statement typically excludes non-recurring items like one-time expenses (e.g., restructuring costs, legal settlements) or unusual gains (e.g., asset sales).
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