The terms pro forma financial statements, financial projections, financial forecasts, and financial budgets are often used interchangeably, but they are not the same thing.
Pro forma comes from a Latin phrase meaning for the sake of form, and in business terms usually relates to a transaction or event which has not yet taken place.
What are Pro Forma Financial Statements?
The term pro forma financial statements simply refers to a set of financial statements in the usual format (balance sheet, income statement, and cash flow statement), which have been prepared in order to show the effects of a transaction on the historical financial statements of a business prior to the transaction actually taking place.
The pro forma financial statements are generated by applying pro forma accounting adjustments to the historical financial information.
For example, a business might be considering the disposal of part of its operations, and will issue pro forma financial statements to show what the historical financial statements would have looked like if the disposal had already taken place. Although the transaction is in the future and uncertain, the pro forma financial statements are essentially restated historical information and are not considered to be projections.
Other situations in which pro forma financial statements are used to show the effects of business transactions include for example:
- An acquisition of another business.
- Changes in the capital structure of the business.
- Change in the form of the business.
- Proposed sale of investments and use of the proceeds.
- Merger of a business with another business.
- To eliminate the effect in the financial statements of one off charges.
By way of illustration, a typical example of this is shown in the Facebook pro forma financial statement SEC filing. The pro forma financial statements relate to the acquisition of WhatsApp Inc. and show a balance sheet at 30 June 2014, restated as if the acquisition had occurred on June 30, 2014, and an income statement for the year ended 30 June 2014, restated as if the acquisition had occurred on 1 January, 2013. The acquisition of WhastApp Inc. was in fact completed later on 6 October 2014.
Format of Pro Forma Financial Statements
Pro forma financial statements are similar in appearance to the historical financial statements of the business, except some of the historical figures are restated to show the impact of the future event or transaction.
Depending on the transaction involved, a business might prepare all three of the main financial statements as a pro forma, balance sheet, income statement, and cash flow statement, or only selected statements if the impact on the others is not considered material.
Pro Forma Balance Sheet
The pro forma balance sheet shows a financial snapshot of the business at a specific point in time restated for the expected impact of the future transaction. As with any balance sheet, it sets out the assets, liabilities and equity of the business.
|Long term assets||120,110|
|Total liabilities and equity||256,163|
Pro Forma Income Statement
The pro forma income statement shows the financial performance of the business over an accounting period restated for the expected impact of the future transaction. The same as all income statement, it shows the revenue less expenses and resulting net income of the business.
|Cost of sales||134,894|
|Research and development||25,347|
|Sales and marketing||24,368|
|General and administrative||23,021|
|Income before tax||59,679|
|Income tax expense||11,936|
Pro Forma Cash Flow Statement
The pro forma cash flow statement like any cash flow statement, shows the cash inflow and cash outflow of the business over an accounting period except that the figures are restated to show the expected impact of the future transaction or event.
|Add back depreciation||30,027|
|Proceeds from long-term debt||50,000|
|Proceeds from issue of capital||10,000|
|Repayment of long-term debt||-11,112|
|Net cash flow||4,891|
|Beginning cash balance||60,943|
|Ending cash balance||65,834|
To summarize, pro forma financial statements allow a business to show the impact of a transaction or event on the historical financial statements, but they are not the same as financial projections, forecasts, and budgets.
Pro forma financial statements are a useful business planning tool whose purpose is to provide additional information to managers, investors, and lenders about the effect of a proposed transaction.
The pro forma financials are often used when a business is seeking finance, undertaking a merger or acquisition, or a capital restructuring, and are usually presented in the same format as the historical financial statements, to allow comparisons to be made.