What Is A Pro Forma Income Statement?
Pro Forma Income Statement (also known as pro forma profit and loss) means how the adjusted income statement will look when certain assumptions, like non-recurring items, restructuring costs, etc., are excluded or if a loss-making unit is discontinued.
When used in a business plan, it represents financial forecasts based on managers’ or analysts’ assumptions about the company. There is an analysis of past performance and future assumptions based on which the projection is made. It gives stakeholders a view of the entity’s current and expected financial condition. Thus, it should be clear and accurate.
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Pro Forma Income Statement Explained
A pro forma income statement in business plan is the statement prepared by the business entity to prepare the projections of income and expenses, which they expect to have in the future by following certain assumptions such as competition level in the market, size of the market, and growth rate, etc.
Although it provide a better picture, it is prudent for the investor to dip deep and analyze what is included/excluded and why so? It also advised comparing the pro forma and actual statements to understand them better.
Let us look at the various types of the pro forma income statement in business plan.
#1 – Pro Forma of Historical Profit and Loss Statement
This happens when the business plans to make some retrospective changes in the income statement. For this purpose, the line items need to be adjusted so that the changes are reflected from the past years.
#2 – Pro Forma Projections of Income
Projections help in forecasting the future of the business based on its current financial condition. Thus, using the concept of conservatism, though consideration of certain important items. Below are the pro forma income statement sample of Alibaba. The projection of revenues is based on many assumptions, including growth rate, competition, market size, etc.
Below is a pro forma income statement sample. As noted below, Amazon removed its non-recurring charges, including restructuring costsRestructuring CostsRestructuring Cost is the one-time expense incurred by the company in the process of reorganizing its business operations. It is done to improve the long term profitability and working efficiency. This expenditure is treated as the non-operating expenses in the financial statements. and stock-based compensation, to correctly represent its Net Income.
source: Amazon SEC Filings
- Forecasting revenues are the most difficult part of any business plan. In a pro forma income statement for new business the assumptions have to be realistic and should be able to support the forecast. It is used to produce the Cash Flow Statements and Balance SheetsBalance SheetsA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company., all of which are important business plan components.
- It may be prepared in advance of a transaction to project the company’s future status. For example, if a company is planning to acquire another company, it may prepare a pro forma income statement format to estimate what effect the acquisition would have on its finances.
- Pro forma profit and loss statements can also be used to calculate the financial ratios.
- If a company has a one-time expense, it may drastically reduce its net income in that particular year. This cost is irrelevant in subsequent years. Hence companies exclude such costs while making the pro forma profit and loss to give investors and analysts a better picture of the company’s financial position.
- For some companies, the pro forma profit and loss statements provide a clear and accurate view of their performance, given the nature of their business. Example: telephone and cable companies.
- One of the major drawbacks is that it is just a mere projection, the future of which is uncertain. The basis of any pro forma is the assumptions made. If the assumptions are inaccurate, it may lead to inaccurate planning and execution. Past data may not always help to paint the correct picture in a dynamic and ever-changing business environment.
- Since there are no set rules while making such a pro forma, companies tend to manipulate their financial earnings. Companies can exclude anything it believes that conceals their true financial performance.
- Some pro forma income statement format exclude unsold inventory from their statements, which, in a way, portrays inefficient management to produce inventory that cannot be sold.
- It does not mean that every firm manipulates its earnings. Hence while evaluating, investors and analysts should pay attention to what is and is not included while preparing the pro forma income statements.
- The pro forma income statement for new business may not provide the desired result because there are not enough data to create the statements, since the business has been operation for a short period.
This article has been a guide to what is a Pro Forma Income Statement. We explain it along with examples, its types, benefits and limitations. You may learn more about Accounting from the following articles –