Explaining Pro-Forma Statement in Context
Sections below further define and explain Pro-Forma statements in context with related concepts, emphasizing three themes:
- First, the pro-forma statement role as a "Preview" of a statement to arrive later.
- Second, various purposes and kinds of pro-forma Statements in use, and when to use a pro-forma Statement.
- Third, the nature and use of the pro-forma Invoice.
- What is a pro-forma statement?
- What is the purpose of pro-forma statements?
- What is a pro-forma invoice?
Pro-forma financial statements often serve to preview likely outcomes of a proposal action, such as.
- New business start up.
- Business expansion.
- Merger or acquisition.
- A Capital investment.
- Change in capital structure (e.g., through bond issue or bank loan).
The pro-forma statements serve in this way to anticipate results of the action by showing the likely future status of the firm's financial statements. This information is of keen interest to decision-makers who must either approve or disapprove the proposal action: Directors, corporate officers, planners, lenders, regulatory agencies, and potential partners
Pro-Forma Statements for Partnerships or Alliances
Before undertaking a merger or lliance agreement, all parties to the proposal action need assurance that each party can look forward to a healthy business status for the foreseeable future, after joining together. Credible Pro-Forma financial statements, for each party, help provide this assurance.
Pro-Forma Statements Before Taking on New Debt
Firms seeking to increase their capitalization in the near term generally have available only two avenues for acquiring the necessary funds. They may either (1) issue new shares of stock, or (2) acquire new debt (secure bank loans or issue new bonds). In all such cases, potential lenders and regulatory agencies need assurance, before approving actions, that the firm's financial structure sill remain sound, and that the firm will be able to service a new debt load and fund expanded operations, all without unacceptable risk.
Pro-Forma Statements for Budgeting and Planning
A pro-forma Income Statement and Balance Sheet might serve, for example, to help determine the necessary amount and timing of a company’s future cash requirements. pro-forma statements show the form and contents likely in the real statements, including estimates or projections acting as "place holders" for figures still under development.
Pro-Forma Statements for Company Start Up
Similarly, Pro-forma statements for a proposing a company start up might serve as part of a funding request to potential investors or loan institutions, intending to show that the new company will be profitable and financially sound. Venture capital funding entities, especially, will seek this kind of assurance.
In this capacity, pro-forma statements are essentially the heart of the business case for funding the company. Pro-Forma business results and other projections in this kind of business case call for a thorough, credible risk and sensitivity analysis to show:
- The likelihood of other outcomes besides the target outcome or the most likely outcome.
- Risk factors that could lead to undesirable outcomes
- Contingencies and critical success factors the firm must manage to target levels, in order to reach target outcomes.
Another form and use of pro-forma statement is the Pro-Forma Invoice. A pro-forma invoice is not an actual demand for payment. Vendors and services providers may submit a Pro-Forma invoice to potential customers or clients before they sign a purchase contract, in order to show likely billing categories, cost estimates, and the classes of information that will appear on the real invoice.
When a pro-forma invoice is used in this way, customer management may approve a purchase or sign a contract, even though the true costs will not be known precisely until an actual invoice arrives later.