What Does Pro Forma Mean?
You may be wondering, what does “pro forma” mean? Basically, it is a fancy word for “future” or “projected.” Sometimes, however, it is used to restate financial books in an unofficial way.
For example, a company might present a “pro forma” income statement of what its income may have looked like if it did not include the money-losing division it sold off. But for our purposes, we will be using the first definition.
A Pro Forma Statement Is an Important Tool for Planning Future Operations
For my purposes here, a pro forma income statement is similar to a historical income statement, except it projects the future rather than tracks the past. If the projections predict a downturn in profitability, then you can make operational changes, such as increasing prices or decreasing costs, before these projections become reality.
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Pro forma income statements provide an important benchmark or budget for operating a business throughout the year. For example, they can determine whether expenses can be expected to run higher in the first quarter of the year than in the second. They can also determine whether sales can be expected to run above average in, let’s say, June. They can determine whether your marketing campaigns need an extra boost during the fall months. All in all, they provide you with invaluable information—the sort of information you need to make the right choices for your business.
More financial statements samples for your business: Sample Business Plan financials
How Do You Create a Pro Forma Income Statement
Sit down with an income statement from the current year. Consider how each item on that statement can or will be changed during the coming year. This should, ideally, be done before year’s end. You will need to estimate final sales and expenses for the current year to prepare a pro forma income statement for the coming year.
Pro Forma Gross Profit
Let’s assume that you expect sales to increase by 10 percent next year. You multiply this year’s sales of $1,000,000 by 110 percent to get $1,100,000. Then, in this case, you assume there will be no increase in the cost of each item you are selling, but you will need 10 percent more items to sell in order to achieve your sales goals. So, you multiply this year’s cost of goods sold (let’s assume a figure of $500,000) by 110 percent to get $550,000.
To figure your pro forma gross profit for next year, subtract the pro forma cost of goods sold from the pro forma sales. Thus, $1,100,000 minus $550,000 equals your gross profit, or $550,000.
This is, of course, a very simple example. What you really want to do is take into consideration everything possible to project sales. Are you going to launch new products? New promotions? Change pricing? Expect new customers? All of these items should be carefully figured into creating sales projections.
Pro Forma Total Expenses
Let’s assume salaries and other expenses will increase by 5 percent. So, you multiply your historical salaries of $200,000 and your historical expenses of $100,000 by 105 percent each. Your pro forma salaries for next year will be $210,000 and your pro forma expenses will be $105,000. You then figure your pro forma total expenses by adding pro forma salaries and pro forma other expenses together. In our sample case, your pro forma total expenses will be $315,000.
I would give a lot of thought to every single expense line item. Is there any way you can cut this cost? Is the cost projection realistic?
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Pro Forma Profit Before Taxes
Pro forma profit before taxes is figured by subtracting the pro forma expenses from the pro forma gross profit, or $315,000 from $550,000, for a pro forma profit before taxes of $235,000.
Pro Forma Taxes
Pro forma taxes are figured by taking your estimated tax rate—in this case, 30 percent—and multiplying it by the pro forma profit before taxes of $235,000. This produces a pro forma tax bill of $70,500.
Pro Forma Profit After Taxes
Pro forma profit after taxes is figured by subtracting the pro forma tax bill of $70,500 from the pro forma profit before taxes of $235,000. Your pro forma profit after taxes, in this case, would be projected at $164,500.
Remember that pro formas are essentially best guesses. You should continually update your projections by recalculating your pro formas using any new and actual financial information you have as a base. Doing this on a monthly or quarterly basis will help ensure that your projections are as accurate as possible.
Pro Forma Income Statement Example
Before creating your own pro forma income statement, take a look at our sample pro forma income statement: