Financial modeling is hard enough without throwing mysterious, intimidating terms like “pro forma” into the mix.
But creating pro forma financial statements is essential for any fiscally responsible business. Accurate pro forma statements can be the difference between your startup tanking or receiving necessary funding. They can also help you assess financial risks and even make the case for an upcoming acquisition.
But what does pro forma mean? And what’s included in a pro forma financial statement? Learn more about what these documents are and how they can help your business below.
What does pro forma mean (and what can these statements do for your business)?
Pro forma is a Latin term that means “for the sake of form.” In financial modeling, it means walking through a series of financial “what if” statements to create hypothetical projections. Based on assumptions detailed in your pro forma statements, you can show the impact of changes on your business.
Businesses in any stage of development or maturity can make use of pro forma financial statements. However, there are several situations where these types of documents are especially useful.
You can use pro forma statements to project best, worst, and expected case scenarios when seeking funding from investors. With these different scenarios, you can show how your business could grow—and how investors could stand to profit—after receiving the funding it needs.
Caption: Show how funding will impact your business with pro forma financial statements.
It’s important to note here that the SEC prohibits publicly traded companies to use pro forma results to mislead potential investors. However, for startups that lack the historical financial data more established businesses use to create financial projections, pro forma estimates can be a thought exercise that demonstrates how a business will be profitable in the future.
You can also use pro forma statements to explore and understand the range of possible financial outcomes for your business.
By adjusting various assumptions in your statements, you can show how fluctuations in income, revenue, or debt could impact your business. Taking a look at the worst possible outcomes of these assumption adjustments can help you understand whether your company can weather potential financial hardship.
Mergers and acquisitions
Finally, you can combine your company’s pro forma statements with those of a company you’re looking to merge with, acquire, or be acquired by. By combining the statements from your two companies, you can create a hypothetical projection of what your finances would look like if your merger or acquisition comes about.
What’s included in pro forma financial statements?
Pro forma financial statements typically include several basic sections. Below, I’ll describe each of the sections and point out what investors can learn from them.
This part of a pro forma statement can help you track or highlight the assumptions you’re making to create your projections.
If you’re making an assumption about how much funding you’ll receive, you can highlight how your business could perform if underfunded, versus how it does if you meet your funding goals.
Creating a separate section for your assumptions can also help you more easily adjust your pro forma statements over time. As you accumulate more financial data, you can make more educated assumptions about what might happen in the future.
Clearly outline assumptions can draw investors’ eyes to important numbers that can fluctuate over time. It can also cut down on questions investors might have about your numbers when your assumptions are transparently laid out.
Your pro forma income statement shows your business’s profitability over time. Based on your assumptions, it shows what the following numbers could look like for your business:
- Cost of goods (COGS)
Your income statement is where potential investors can see what their ROI could over time if they inject funding into your business.
Your pro forma cash flow statement shows how cash will enter and leave your business. Cash flow statements detail cash from the following activities:
By analyzing your potential cash flow, investors can see how your business plans on using its available cash. If you’re projecting a cash shortage in your worst case scenario, it can also give you a chance to explain or demonstrate how your business would navigate that difficulty.
Your pro forma balance sheet outlines the following figures:
- Your assets—What your business owns
- Your liabilities—What your business owes
- Your equity—The difference between your assets and liabilities
Caption: Show investors how it all adds up with a pro forma balance sheet.
Your balance sheet is where you can show investors how your business plans to conduct itself financially. For example, if you produce a physical product, you can show how much potential funding you plan to put into inventory or production equipment. It can also help highlight any debt your business has taken on or plans to take on over time.
Why do startups need pro forma projections?
Startups can use pro forma statements to explore how sound their business plans are. By creating assumptions and adjusting them, you can also see how your startup may move forward in the best-case scenario. You can also plan ahead to keep your business afloat in case you run into your worst-case scenario.
Startups seeking funding can also consider pro forma financial statements as a chance to convey the potential of their businesses. If you received much-needed funding, your business could become highly profitable, and your backers will see a high return on investment. And if you have a really good business idea, even your worst case scenarios could make your startup seem like a sound investment.Startups seeking funding can also consider pro forma financial statements as a chance to convey the potential of their businesses. Click To Tweet
Ultimately, startups can use pro forma financial statements internally to prove their future profitability and evaluate potential future risks. Externally, these statements can show investors whether a startup is worth investing in or if it’s a dud.
Create pro forma statements that will get you funded
Any business looking to grow should create pro forma statements to better plan for financial fluctuations over time.
These statements involve many moving parts. And calculating all the figures accurately can require in-depth business accounting knowledge or extreme comfort with Excel spreadsheets.
Luckily, a quick search reveals quite a few resources available to those looking to create pro forma statements. You can access lots of guides and templates—many of them free!—to create them. You could also use a third-party accounting service to create your projections.
However, templates still require manually tracking lots of data and checking to ensure there are no errors in your spreadsheet formulas. And third-party services will likely create thorough, accurate statements…but at a high cost.
RaiseIQ offers an alternative to navigating spreadsheets for days and paying high prices for professional services. You can use its financial modeling tools—based on financial accounting best practices learned at Harvard Business School—to create five-year pro forma statements that impress investors. Join the waitlist for RaiseIQ’s financial modeling software that will help you create pitch deck-ready statements that will get your startup funded without the headache.