What are pro forma financial statements?
Pro forma financial statements are the complete set of financial reports issued by an entity, incorporating assumptions or hypothetical conditions about events that may have occurred in the past or which may occur in the future. These statements are used to present a view of corporate results to outsiders, perhaps as part of an investment or lending proposal. A budget may also be considered a variation on pro forma financial statements, since it presents the projected results of an organization during a future period, based on certain assumptions.
Here are several examples of pro forma financial statements:
- Full-year pro forma projection. This is a projection of a company's year-to-date results, to which are added expected results for the remainder of the year, to arrive at a set of full-year pro forma financial statements. This approach is useful for projecting expected results both internally to management, and externally to investors and creditors.
- Investment pro forma projection. A company may be seeking funding, and wants to show investors how the company's results will change if they invest a certain amount of money in the business. This approach may result in several different sets of pro forma financial statements, each designed for a different investment amount.
- Historical with acquisition. This is a backward-looking projection of a company's results in one or more prior years that includes the results of another business that the company wants to purchase, net of acquisition costs and synergies. This approach is useful for seeing how a prospective acquisition could have altered the financial results of the acquiring entity. You can also use this method for a shorter look-back period, just
to the beginning of the current fiscal year; doing so gives investors a view of how the company would have performed if a recent acquisition had been made as of the beginning of the year; this can be a useful extrapolation of the results that may occur in the next fiscal year.
- Risk analysis. It may be useful to create a different set of pro forma financial statements that reflect best-case and worst-case scenarios for a business, so that managers can see the financial impact of different decisions, and the extent to which they can mitigate those risks.
- Adjustments to GAAP or IFRS. Management may believe that the financial results it has reported under either the GAAP or IFRS accounting frameworks are inaccurate, or do not reveal a complete picture of the results of their business (usually because of the enforced reporting of a one-time event). If so, they may issue pro forma financial statements that include the corrections they believe are necessary to provide a better view of the business. The SEC takes a dim view of this kind of adjusted reporting, and has issued regulations about it in their Regulation G .
There can be a significant problem with issuing pro forma financial statements to the public, since they contain management's assumptions about business conditions that may vary substantially from actual events, and which may, in retrospect, prove to be extremely inaccurate. Generally, pro forma financial statements tend to portray a business as being more successful than it really is, and having more financial resources available than may actually be the case. Consequently, investors should be extremely careful when evaluating these types of financial statements.