Pro forma is generally a hypothetical projection of your business’ financial stability. It details realistic expectations of your business income and expenses and includes cash flows, assets, liabilities, and losses, covering a specific period of time, usually monthly, quarterly, and yearly basis. Pro forma financial statements are necessary when mapping out a business plan. Along with the business plan, pro forma statements are requirements when making a bank loan or securing the approval of investors. Here is a guideline to follow when preparing a pro forma statement.
- Determine your expected income. Important in making a pro forma statement is a realistic assumption of your income. How do you foresee the performance of your business? Based on your pricing and the current market trend, how much will your business make in a month? In a quarter? In a year? Will the income come from one source or do you expect to earn from other streams? When determining the projected income, the tendency is to state only the optimistic scenario, overlooking other factors that may affect your revenue such as competition and market responses. To get accurate projections, research other businesses of the same type and see how they perform financially.
- Identify potential financial outflow. This includes expenses, operating costs, wages, taxes, and losses. Again, be realistic. Detail how much you will spend for rental, utility, employee wages and benefits, tax payments, and dividends. You may also have to deal with losses, so have loss projections and determine the scenarios that can potentially lead to such.
- Assemble a cash flow projection. The cash flow will primarily indicate the income, expenses, and other financial data in a tabular form. When all the information and details are presented in such a way, you can have a better view of your financial projections and make financial analysis.
- Consider three possible scenarios. When making pro forma statements, it is best to factor in three possible financial scenarios: optimistic (best scenario), normal, and pessimistic (worse scenario). Prepare pro forma statements for such scenarios in a columnar format. Then, analyze and compare the possible outputs of the scenarios.
- Use computer software when making a pro forma. Using financial software saves you from the laborious task of manually calculating and organizing all the details. Financial software is designed to do the task for you and helps you achieve a presentable and competently laid-out pro forma financial statement.
- Provide explanations for your projections. Numbers cannot explain themselves, so always include notes explaining how you came up with your projections. Bank and investors are interested to know the fundamental logic behind your analyses and forecasts, which will enable them to conduct their own examination and comparison.
Financial projections will take some time to make and will, in fact, be somewhat challenging. But you have to proficiently deal with it because having pro forma statements does not only help you get loans and investors, but will also help you avoid financial problems when the business is already in place.