In this lesson, we’re going to be explaining commonly asked questions about pro forma, financials. We’re going to take a look through six. Very commonly asked questions, ranging from you’ll what are pro forma financials? When are they useful? Are there different variations of them and how does this relate to GAAP (Generally accepted accounting principles)? And some of the other words and terminology that I’m hearing anything interesting happening in the past or any laws that I need to know if I’m involved in pro formas. And finally, if I’ve decided I want to actually create my own pro forma. How do I even get started?
So let’s dive in the first question you need to ask if you’re wondering know what is a pro forma financial statement is to figure out what does pro forma mean and the term pro forma actually comes from a Latin word and it means as a matter of form, it’s the style or the way that we’re putting together these different projections. Means we also need to understand what our financial statements pro forma financial statements. We know that pro forma is referring to the form so we’re kind of saying their projections. They’re going to fall into the form of financial statements. Let’s think what are the three key financial statements income statement, balance sheet and cash flow? So when it comes down to it, a pro forma financial statement is nothing more than your projection, meaning your guess your estimate, what you Believe will happen in the future, on your company’s income statement, your balance sheet and your cash flow just to do a quick recap. Your income statement is going to capture the revenue and expenses of your business. Meaning what? What you’re selling to your customers and what it costs you to sell your balance sheet is going to be covering what your company owns, what it owes to people and what your shareholders own and have invested in the company. And finally, your cash flow is really going to be telling you all of the different financing investing and operating activities that you’re involved in. So now we have kind of an idea that these Pro formas are something writing a projections that are put into this format but when are they actually useful and when are they not useful? Well let’s start with when they’re not useful So pro formas are not going to be capturing information on the past or historic information. They’re not going to be capturing your actual records of what happened for that reason. They don’t tend to be used very often for compliance or any tax reasons because they’re not telling you what actually happened. Your pro forma projections, are telling you your plans, what you see into the future. When do they become helpful? Well, actually in pretty much any scenario where you’re trying to plan your business, you’re in particular, if you’re in a growth environment because if you’re in a growth environment, you’re likely to be needing to do things with your company different than you’ve done in the past. Right? If you do the same things as you’ve done in the past, you’re going to get the same financial results as you caught in the past so pro forma. Can be particularly helpful if you’re in scenarios, where your company really wants to grow, maybe you want to be involved in mergers and Acquisitions with a large company, or maybe you’re just really wanting to grow organically, meaning just your pro forma financial projections, can kind of give you a picture of all this effort that I’m going to put into my business. What’s that going to translate to in terms of future financial results? So really when you think when do you use pro forma financials anything focused on the future? But then you need to kind of ask yourself. Well, is there more than one pro forma Financial? Well, that becomes your decision as the person preparing the pro forma financials. The reality is none of us have a crystal ball. So anytime we’re doing projections about the future, we may actually not get it right. We might think the future will be a little bit. Rosie might be a little bit worse, we’re really making guesses, we’re making our best guesses, our assumptions about what’s going to happen into the future. So oftentimes a company will discuss establish what we call their Baseline projections or their Baseline assumptions for what they think is going to happen and what they’re going to really try hard to hold themselves to. But it is also often very wise to also have multiple versions of your pro formas that maybe serve different purposes. You may want to create a pro forma financial projection that captures a little bit more on the conservative side and if this happens, and if that happens will we be able to keep the lights on in our company and you may also want to have a scenario that’s a little bit more aggressive and if these good things happen and and we hate our different targets you know what might that actually mean for a company’s Financial so that we can plan accordingly. There’s no one single version of your pro forma financials though. It is common to have a agreed-upon base, so that people are kind of working towards the same target, but you can get a lot of insights by running pro forma financials across a range of different assumptions because it just sets you up that much. Better thinking back, two years ago, none of us would have ever projected that something like covid-19 pin’. So you can see the importance of having different ranges of projections in your pro forma financials. What think your pro forma financials? Look like compared to say GAAP. While GAAP is your Generally accepted accounting principles which are used in the United States. Other parts of the world such as Organic use IFRS. So GAAP and IFRS are similar in tha they are both the reporting standards that we use whenever reporting on information. That happened in the past historic information. But remember that with pro forma Financial projections, we’re talking about the future so it can be helpful to follow similar conventions when you’re putting together your pro forma financials. So that when the actual results come in and you can compare and see know how did we actually do? It’ll be a little bit more comparable for yourself to be able to compare your financials. If they were somewhat more consistent with the way that you’re reporting your past information, whether that’s using gap or using IFRS. So they don’t have to follow as prescriptive requirements to adhere to gaap and IFRS. But the more similarities you can draw on in your projections, the easier it will be for you too. Actually go at the end of the day and say, you know, was was our projections about what’s going to happen? Did we completely miss the mark, or were we close to our target. There can be can be helpful but not a strict requirement.
You might be wondering, you know, are pro, formas, new and like can I do them wrong? Is there some law out there that I need to be following for pro formas? Well to answer your first question are ProForm as new no proof Form is have been around for as long as businesses have been around. So if you imagine way back in early Merchants exchange days, they may not have had the same level of sophistication that we currently have. Whenever we look at our pro forma Financial projections but presumably the different merchants of the day would kind of plan the different spices and items that they might want to sell and trade with other Merchants so they were probably doing their own perhaps less sophisticated version of estimating What is that going to look like for their company’s profit and for their company’s profitability?
So the concept of planning for your future and going through the exercise of a pro forma is absolutely not new. Can I do it wrong though? You know, is there a law out there that I must do my proforma, as a particular way? Well, there certainly are a lot of regulations Around The Way We report on actuals, but it’s incredibly challenging to be very prescriptive around the estimates. We’re making about the future. No one knows what the future is going to entail, so they really isn’t the same level of rigor around, what your future, estimates are for your company. Because no one really knows that some of that future has to get dictated. There are a certain number of publicly traded companies. That will issue what we call investor guidance. And there are some requirements that they need to make sure that they are being careful in the way that what they’re signaling to investors. But by and large the laws around financial statements tend to be more focused on the actual information. What truly happened? What recorded? What’s what’s historical what happened in the past? Because it’s very very challenging to really legislate what’s going to happen into the future.
How would I even go about creating a pro forma? Well, there’s broadly for core steps that you’re going to go through. And of course, the more complex, your businesses, those four steps can obviously become far far, far more complex than that, but where you’re going to want to start with is what are the revenue drivers for your business? You know, is it, customers is a subscription count? Is that what’s the drivers that are actually bringing revenue and customer and money through the door for your business? Start with that, as kind of one of your baselines to figure out with some of your assumptions are going to be, then you want to marry along. What’s the associated cost structure for me to be able to achieve that level of business to be able to satisfy those customers? So you may have certain costs that are fixed that. Don’t really go up. Even if your sales grew exponentially but you likely have a subset of your costs that are very variable. So you want to make sure that you then project out. How’s your cost structure going to move along with where your customers are moving. Then we come into F3, which is where you’re going to figure out your funding is you’ll remember the financial statements cover. Not only your income statement but they’re also going to cover a lot of your balance sheet where you’re going to need to figure out. You know. Do we have the money? We need to be able to invest in equipment. Do we have everything? We need to be able to pay back our various different debts, all of those type of areas, you’re going to want to factor that into your complete set of your pro forma financials. And then, of course, there will be a step where you’re going to want to. Three to layer in the many other adjustments that will be reflected for all of the projections of, you know, what’s going to be different in the future versus where you are now. So, if you supposed those four broad steps, it will give you a structure to get started on creating your pro formas. And then you can always step back and say, does this make sense? Is this a view of the future?
Now you know the answers to six commonly asked questions about pro forma financials.