Pro forma statements are financial estimates used by companies to project future earnings, receivables, inventory or other quantifiable entity estimate. They utilize known information and hypothetical numbers to complete projections. Pro forma statements are used for start-up businesses to find venture capital, get bank loans or estimate the cost of doing business. While a pro forma offers no guarantee, when done right it demonstrates that management has done its homework with accurate assumptions based on industry standards.
Primary Improtance
Pro forma statements are used to create a budget and determine the need of the company for capital. This need can be short-term or long-term with the pro forma statement extending through years of growth. This gives management realistic numbers of cash needs. By anticipating this need, they won't be unprepared when the need is realized.
Growth Opportunities
Pro forma statements can demonstrate the areas in which a company can grow by adjusting numbers that deal with distribution to affect the bottom line. By working these numbers and how they affect real costs, a company can judge whether growth is worth the risk and cost. When a company is considering leaping to the next level, it needs to understand that it isn't merely a cost of production and retail cost that affects the net revenues of a company. Increasing production may increase needs for insurance while decreasing the cost of production because materials can be discounted for buying greater bulk. More employees may be needed with more benefits. There are many factors to consider and pro forma statements help review all of them.
Capital Investors
When any company, young or old, seeks venture capital or bank financing, it will be required to produce balance sheets and financial statements. If the company is established it will have its records already in tact from tax returns and bookkeeping records. New companies will need to create an idea of how the company is going to be profitable. Even established companies seeking growth capital need to show the difference between what they have been doing and what they can be doing with new capital influx. This is where pro forma statements help show investors that the company and its management have considered all variables. It gives confidence to investors.
Troubleshooting
Established companies can take their actual financial statements and make adjustments based on pro forma data assumptions and find areas to cut costs, improve performance and generate more revenues. In doing so, they are able to see the gaps in their current performance and make minor or major adjustments as deemed necessary to rectify any problems. By using pro forma statements to troubleshoot, companies may realize a better way of doing the same thing.
Adjustable Projections
Because pro forma statements are estimates, they are flexible and allow for things to be adjusted as needed. Whether they are changes made as suggestions by investors or other ideas that adjust costs, the pro forma statement is dynamic. As the company gets to the implementation stage, actual numbers easily replace the hypothetical assumptions to give an accurate depiction of costs, revenues and returns on investment data. The pro forma statement then easily transfers into becoming a comprehensive financial statement for the company that shows how well their comparisons compare to actual numbers.
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