Pro forma financial statements: What to include and how to create them

Running a small business comes with plenty of uncertainties, especially when it comes to finances. You spend most of the time wondering how to plan for the future, but it’s tough to make informed decisions, secure funding, or plan for growth without a clear financial forecast. Enter pro forma financial statements. 

Pro forma modeling helps you predict your financial future by estimating profits, cash flow, and expenses under different scenarios. In this article, you’ll learn what to include in these statements and how to create them so you can plan your next move with confidence.

Jump to:

• Key pro forma financial statements components
• Types of pro forma financial statements
• Pro forma vs. GAAP financial statements
• Applications of pro forma financials
• How to create pro forma financial statements
• Limitations and risks of pro forma financials
• Spend more time growing your business
• Pro forma financial statements FAQ

Key pro forma financial statements components

Creating pro forma financial statements involves several elements that paint a clear picture of your business’s potential financial future. Here are the key components to include:

• Hypothetical data and assumptions: Pro forma analysis starts with educated guesses. You’ll base your projections on past performance, industry trends, or new business strategies. These assumptions help shape the rest of your forecast.
• Revenue projections: You can conduct financial projections forecasting by considering market conditions, sales growth, and new products or services. This gives you an idea of how much money you might bring in over a specific period.
• Expense forecasts: Don’t forget to factor in the costs. Include both fixed and variable expenses, such as payroll, rent, and materials, to ensure your pro forma reflects realistic financial outcomes.
• Asset and liability estimates: Your pro forma should also estimate asset changes, like equipment and inventory, and liabilities, such as loans or accounts payable. This helps balance your financial picture.

These components come together to help you understand your business from both a finance and accounting perspective. While finance focuses on forward-looking projections, accounting relies on historical data—pro forma financial statements help bridge the gap between the two. Accounting software with advanced accounting capabilities, like QuickBooks, can help here.

Types of pro forma financial statements

Pro forma financial statements come in various forms, each serving a unique purpose in your business planning. Let’s explore the most common types.

Income statement 

A pro forma income statement projects your business’s revenue, expenses, and profits over a set period. It provides a better understanding of future profitability, helping with pro forma valuation and decisions like pricing or cost-cutting. By using a pro forma model, you can simulate how changes in sales or expenses will impact your bottom line, making it easier to choose a strategy for growth. 

Cash flow statement

Cash is king, and the pro forma cash flow statement forecasts your future inflows and outflows. This projection ensures liquidity and operational efficiency. A solid financial forecasting strategy helps you avoid cash shortfalls by showing where funds are coming from and how you’ll spend them. 

Balance sheet

This statement estimates your future assets, liabilities, and equity. A pro forma balance sheet helps you choose a financial forecasting model that accurately predicts your company’s financial health. By comparing this forecasted balance sheet with current numbers, you can assess whether you’ll need additional funding or how future growth might affect your capital structure. 

Specialized projections

Sometimes, you'll need more tailored forecasts, like full-year projections or risk analysis. These specialized pro forma models help you prepare for specific scenarios, such as market downturns or expansions, allowing you to pivot when needed. They also provide valuable insights into the risks and opportunities tied to different financial strategies, helping you make informed decisions with greater confidence.

Pro forma vs. GAAP financial statements

While both pro forma and GAAP financial statements are useful tools in financial reporting, they serve different purposes and follow different rules.

• Purpose and focus: Pro forma modeling is primarily focused on forecasting and flexibility, allowing businesses to create projections based on hypothetical scenarios, such as launching new products. In contrast, GAAP accounting emphasizes accuracy and consistency by presenting a company's financial position based on historical data.
• Data adjustments: Pro forma statements enable adjustments to historical data, accounting for one-time expenses or anticipated future revenue streams, which allows for assumptions and projections. Conversely, GAAP statements strictly adhere to recognized accounting practices, ensuring that the financial information presented is standardized and reflects a true and fair view of past and present financials.
• Usage and compliance: Pro forma modeling is ideal for strategic planning and scenario analysis, allowing businesses to explore various outcomes. On the other hand, you need GAAP financial statements for compliance—they standardize reporting to external stakeholders, including investors and regulators.

Compliance considerations

Publicly traded companies must use GAAP statements for official reporting to investors, regulators, and tax authorities, as required by law. These statements must follow strict accounting rules to ensure transparency and consistency.

In contrast, businesses use pro forma financial statements for internal decision-making or investor presentations, especially when highlighting future potential rather than past performance, without the constraints of GAAP.

Applications of pro forma financials

Pro forma financial statements can play a vital role in various aspects of business operations. Here are some cases where you can use them:

• Strategic planning and budgeting: Pro forma financials help businesses forecast future revenues and expenses, enabling effective budgeting and strategic planning. By modeling different scenarios, companies can allocate resources more efficiently and set realistic financial goals.
• Investment analysis: Investors use pro forma statements to assess the potential return on investment (ROI) for various projects. By analyzing projected cash flows and profitability, they can make informed decisions about where to allocate their capital.
• Mergers and acquisitions: During mergers and acquisitions, pro forma financials help evaluate the combined financial impact of the entities involved. They allow companies to assess how the merger will affect revenue, costs, and overall financial health, aiding in negotiation and planning.
• Fundraising and investor relations: Pro forma financial statements help secure funding from investors or financial institutions. They demonstrate a company’s growth potential and financial viability, helping build investor confidence and secure necessary capital.

How to create pro forma financial statements

Creating pro forma financial statements involves a structured approach to ensure accuracy and reliability. Follow this step-by-step guide to develop effective pro forma statements:

1. Define your purpose: Start by identifying the specific purpose of your pro forma statements. Whether it’s for strategic planning, investment analysis, or fundraising, having a clear goal will guide your projections.
2. Gather historical data: Collect relevant historical financial data, including income statements, balance sheets, and cash flow statements. This information will serve as a foundation for your forecasts.
3. Make assumptions: Develop realistic assumptions based on market trends, industry standards, and company performance. These assumptions will drive your projections and should be well-researched.
4. Create projections: Using the historical data and assumptions, project future revenues, expenses, and cash flows. Beak these down into monthly or quarterly intervals for a more detailed analysis.
5. Draft financial statements: Compile your projections into pro forma financial statements, including the income statement, balance sheet, and cash flow statement. Make sure to clearly label the assumptions used in your calculations.
6. Review and revise: Once drafted, review the pro forma statements for accuracy and consistency. Seek feedback from team members or financial advisors and revise as needed.

Common pitfalls to avoid

• Overly optimistic assumptions: Avoid overly aggressive assumptions about revenue growth or cost savings. Ensure your assumptions are grounded in reality to create credible forecasts.
• Neglecting external factors: Don’t overlook external factors, such as economic conditions, industry trends, or regulatory changes, which can impact your projections.
• Confusing budget vs. forecast: Understand the difference between budgeting and forecasting. While a budget is a fixed plan for spending, a forecast is a dynamic tool that adjusts based on actual performance and market conditions. Ensure clarity in how you approach both to inform your pro forma financial statements effectively.

Limitations and risks of pro forma financials

While pro forma financial statements can be powerful tools for forecasting and strategic planning, they also come with certain risks and limitations that businesses should be aware of, including:

• Potential for bias: Assumptions may be overly optimistic, leading to skewed projections.
• Misleading comparisons: Without clear differentiation from GAAP financials, pro forma statements may confuse stakeholders.
• Subjectivity: Projections rely on subjective estimates, which can vary widely depending on the creator’s bias or goals.
• Lack of standardization: Unlike GAAP, pro forma financials don’t follow strict accounting rules, making them harder to compare.
• Investor misinterpretation: If not properly explained, investors may mistake projections for actual financial performance.
• Regulatory scrutiny: Public companies must disclose certain pro forma adjustments, as per SEC guidelines, to avoid misleading information.
• Dependence on assumptions: If market trends or company performance change, pro forma assumptions can quickly become outdated.

Spend more time growing your business

Pro forma financial statements help you plan your next big move, but creating them doesn’t have to take up all your time. With accounting tools like QuickBooks Online Advanced, you can simplify your financial forecasting and focus on growing your business. Whether you’re assessing a potential investment or preparing for expansion, accurate projections are key.