Tag Archives | pro forma financial statements

Pro-Forma Financial Statements

See Also:
Proforma Earnings
Balance Sheet
Cash Flow Statement
Free Cash Flow
Variance Analysis

Pro-Forma Financial Statements Definition

In accounting, pro-forma financial statements are hypothetical financial reports that show either forecasts of or alterations to actual financial statements. Pro-forma financial statements show the financial statements of a company in a hypothetical scenario that has not yet been realized or that represents a modification of the actual financial statements. Furthermore, pro-forma reporting is useful for showing what a proposed company would look like or for removing unusual or nonrecurring items from a financial report.

What is Pro-Forma?

What is pro-forma? In Latin, pro forma means for the sake of form. Additionally, pro-forma projections or pro forma reports are simply modified versions of actual financial statements that are made for the sake of showing what these documents would look like under certain hypothetical scenarios.

For example, if an entrepreneur has an idea for a company, and he wants to pitch the idea to potential investors, then he may want to draw up pro forma financial statements to show the potential investors what the company would look like once it’s up and running. In this case, the entrepreneur would create pro forma projections of the various financial statements and present them to the investors.

Or if a company incurs a major one-time cost that is not related to regular business operations, the company may want to show investors what the financial statements would look like without the affects of that major one-time cost. In this case, the company would include pro forma financial statements in its annual report.

Pro-Forma Financial Statement Example

Below is a very simple example of a pro forma income statement. Assume the company underwent a massive corporate restructuring that was very expensive. According to accounting regulations, the company has to include that restructuring charge on its income statement. Because the restructuring charge was so big, it wiped out the company’s income and the company showed a loss for that period.

However, this restructuring charge is a one-time extraordinary item, and is not part of the company’s normal business operations. So, in order to show investors and other interested parties what the company’s income statement would have looked like without that one-time restructuring charge, the company included a proforma version of the income statement in its annual report.

You will see the difference between the original income statement and the pro-forma income statement below. Then notice that removing the one-time restructuring charge turns the company’s loss into a profit. As you can see, the company may want investors and other financial statement readers to see the pro forma financial statement to understand why the company’s regular financial statement showed that the company took a loss during that period.

Regular Income Statement
Revenue                              $500,000
Cost of Goods Sold                    250,000
Restructuring Charge                  300,000
Interest Income                        50,000
Interest Expense                       25,000

Net Income (Loss)                    ($25,000)

Pro Forma Income Statement
Revenue                              $500,000
Cost of Goods Sold                    250,000
Interest Income                        50,000
Interest Expense                       25,000
Net Income (Loss)                    $275,000

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Pro-Forma Financial Statements

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Pro-Forma Financial Statements

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Percent-of-Sales Method

See Also:
ProForma Financial Statements
Cost Center
Weighted Average Cost of Capital (WACC)
Standard Costing System
Activity Based Costing vs Traditional Costing

Percent-of-Sales Method

The percent-of-sales method is a technique for forecasting financial data. When forecasting financial data for strategic planning, budgeting, or for developing pro forma financial statements, analysts can use the percent-of-sales method of forecasting to create reasonable projections for certain key data.

The idea is to see how a financial statement account item relates historically to sales figures. Then use that relationship to project the value of those financial statement account items based on future sales estimates. This method of forecasting requires the items to be estimated based on relations to sales figures, thus it is necessary that movements in the items to be forecast are highly correlated with fluctuations in the sales figures. Forecast that item using a different technique; especially if there is no clear correlation between the item to be forecast and sales figures.

For example, if, after examining and analyzing historical financial statement data, an analyst determines that inventory levels are typically at 30% of sales. Additionally, the sales forecast for the coming year is for $100,000 dollars in sales. Then according to the percent-of-sales method of forecasting, the analyst can estimate inventory of approximately $30,000, or 30% of the estimated sales figure.

If you’re still not sure how to accurately project your sales, click here to access your free Goldilocks Sales Method tool. This tool allows you to avoid underestimating or over-projecting sales.

Three Step Process

There are three steps in the percent-of-sales forecasting process. First, use the sales figures to identify the correlated items. Then separate the uncorrelated out. To do this, analyze historical financial statement data. Only the items which are correlated with sales figures can accurately be predicted or forecast using the percent-of-sales method. Estimate items that have no concrete relation to sales figures using a different technique.

Next, forecast sales for the fiscal period in question. Because all projections in the percent-of-sales method of forecasting depend on relationships between financial statement items and sales figures, it is very important to get an accurate sales forecast.

The third step in the percent-of-sales method of forecasting is to forecast the values of certain appropriate financial statement items. You can accomplish this by using the sales forecast from the previous step in combination with the historical relation between the financial statement item and the sales figure.

Percent-of-Sales Method

1. Analyze historic financial statement data
2. Forecast sales for the fiscal period
3. Forecast financial statement items using sales forecast

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percent-of-sales method

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