Pro forma financial statements: Overview, definition, and example
What are pro forma financial statements?
Pro forma financial statements are financial reports that are prepared based on certain assumptions or projections, often to present the financial position of a company under hypothetical scenarios or after specific events, such as a merger, acquisition, or significant capital investment. These statements are not based solely on historical data but are designed to reflect future projections or the impact of specific business decisions.
Pro forma financial statements typically include the income statement, balance sheet, and cash flow statement, adjusted for factors like acquisitions, disposals, or other anticipated changes. They are used to provide stakeholders, including investors, creditors, and management, with an idea of how a company might perform under various scenarios or after certain business activities.
Why are pro forma financial statements important?
Pro forma financial statements are important because they help businesses and investors make informed decisions based on projected financial performance rather than just historical results. These statements are particularly useful for:
- Business planning and forecasting: Companies can use pro forma statements to model the potential impact of strategic decisions, such as mergers, acquisitions, or capital investments.
- Investor relations: Investors often rely on pro forma financial statements to assess how business changes will affect the company's future performance and profitability.
- Regulatory compliance: In some cases, companies are required to submit pro forma financial statements to regulatory bodies when they are planning significant transactions or changes that might impact their financial position.
- Risk assessment: By analyzing different scenarios through pro forma financial statements, companies can assess the risks associated with various strategic options.
Understanding pro forma financial statements through an example
Imagine a company, XYZ Corp., that is planning to acquire another company, ABC Ltd. To assess the financial impact of the acquisition, XYZ Corp. prepares pro forma financial statements that combine its own financials with those of ABC Ltd. These pro forma statements reflect how the combined company would look after the acquisition, including projected revenues, expenses, and profits.
For example, XYZ Corp. might prepare a pro forma income statement showing combined revenues of $10 million (from XYZ Corp.’s existing business) plus $5 million from ABC Ltd. The pro forma balance sheet would combine both companies' assets and liabilities, giving a clearer picture of the financial standing after the acquisition.
In another example, a company might prepare pro forma financial statements to project the impact of a new product launch. By including estimated sales, production costs, and marketing expenses, the company can use the pro forma income statement to forecast how the new product might affect overall profitability.
An example of a pro forma financial statements clause
Here’s how a clause referencing pro forma financial statements might appear in a business agreement:
“The Company shall provide pro forma financial statements for the upcoming fiscal year, reflecting the expected impact of the acquisition of ABC Ltd. These statements will include a combined income statement, balance sheet, and cash flow statement, adjusted for the anticipated revenues, expenses, and liabilities associated with the transaction.”
Conclusion
Pro forma financial statements are valuable tools for companies and investors to project and assess future financial performance based on assumptions or anticipated events. They provide a hypothetical view of a company’s financial position and help in making decisions related to investments, acquisitions, and strategic planning. By including expected changes in revenue, costs, and business structure, pro forma statements offer an informed perspective on how these events might impact the company’s financial outlook, enabling better decision-making and risk management.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.