A pro forma income statement is a document that shows a business’s adjusted income if certain financial inputs were removed. In other words, it’s a way to show what the income of the business would be if some costs were excluded.
When Would I Need A Pro Forma Income Statement?
Let’s say your business manufactures and sells widgets to the general public. You make widgets for kids, widgets for adults, widgets for dogs, and widgets for cats. Over a period of 6 months, you realize that the widgets for cats are just not selling.
The loss your business incurs because of the cat widgets really makes a big dent in your income, so you decide to stop manufacturing and selling cat widgets. Now you have to liquidate inventory, sell your machinery, and wind down relationships with cat widget vendors.
While all this is happening, it appears on paper that your business is operating at a loss. This is where pro forma income statements come in.
A pro forma income statement showcases all the same inputs from a standard income statement, minus all the costs associated with manufacturing and selling cat widgets. It shows how the projected health of your business minus the cat widgets.
Who Uses Pro Forma Income Statements?
Business owners, accountants, or outside consultants may create pro forma income statements for the following reasons:
- To project the potential income of the business to creditors or investors
- To convince prospective employees of the future health of a business
- To inform management of financial scenarios, like large, one-time purchases
- To help inform decision-making around the acquisition of a company
How To Create a Pro Forma Income Statement
There are two types of pro forma income statements: one that looks backward (historical profit & loss) and one that looks into the future (projections of the income statement).
In either case, the starting point is the company’s income statement. For our widget vendor, let’s say the business owner would initially like to look backward at historical profit & loss.
Take the income statement and add two columns to each quarter you’d like to calculate. In the first column, you’ll list all the costs associated with cat widgets that you’d like to remove. In the second column, you’ll subtract those costs from the total for each figure on the income statement.
The final column is your pro forma, which gives you the historical profit and loss. It shows the business’s adjusted income if you never had any expenses related to cat widgets in the first place.
To create the forward-looking pro forma income statement, you’ll need projections from all areas of the business including projected income from all sales channels and projected costs for all operating expenses. Instead of a comparison like historical profit & loss, you’ll simply have a forecast.
Remember: Pro-formas Are Based On Scenarios
It’s critical for businesses to have the ability to create scenarios, projections, and forecasts—but they must remember that pro forma statements are just that. As in our cat widget example, there’s no guarantee that we’ll be able to liquidate all the cat widgets, sell all the machinery, and close off the relationships with cat widget vendors without any extra cost.
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