How to Make a Pro Forma Income Statement

A pro forma income statement offers a forward-looking financial projection, estimating a business’s future financial performance over a specified period. It is built upon a set of assumptions and projections, serving as a structured estimate of what a business’s revenues and expenses might look like under various scenarios.

Key Components of an Income Statement

The foundation of any pro forma income statement lies in understanding the standard components of a historical income statement. Revenue, often called sales, represents the total income generated from a company’s primary business activities before any expenses are subtracted. This figure reflects the monetary value of goods sold or services rendered to customers.

Directly related to revenue is the Cost of Goods Sold (COGS), which includes the direct costs attributable to the production of the goods or services sold by a company. For a manufacturing business, this might encompass raw materials, direct labor, and manufacturing overhead. In contrast, a retail business’s COGS would primarily consist of the purchase price of merchandise.

Subtracting COGS from revenue yields Gross Profit, indicating the profitability of a business’s core operations before considering overhead expenses. Following gross profit, operating expenses are listed, which are costs incurred in running the business that are not directly tied to production. These include categories like Sales and Marketing, covering advertising and sales commissions, and General and Administrative (G&A) expenses, which involve salaries for administrative staff, rent, utilities, and office supplies.

Operating Income, also known as Earnings Before Interest and Taxes (EBIT), is calculated by deducting operating expenses from gross profit. This metric reveals the profitability of a business’s operations before accounting for financing costs and taxes. Subsequently, Interest Expense is factored in, representing the cost of borrowing money for business operations.

Finally, income taxes are applied to the remaining profit, leading to Net Income, often referred to as the “bottom line.” This figure represents the total profit a business has earned after all expenses, including taxes, have been paid.

Projecting Your Financial Data

Revenue projections often begin with analyzing past sales trends and applying an expected growth rate. Methods include projecting sales volume and pricing per unit, or using a “percent of sales” approach based on a previous period.

Forecasting the Cost of Goods Sold (COGS) frequently involves estimating it as a percentage of projected revenue, especially for businesses with variable production costs. For example, if COGS has historically been 30% of sales, this percentage might be applied to future revenue projections. Alternatively, for businesses with discrete units, COGS can be projected by multiplying the anticipated number of units sold by the estimated cost per unit.

Operating expenses need to be distinguished between fixed and variable costs for accurate projection. Fixed expenses, such as rent, insurance premiums, or administrative salaries, generally remain constant regardless of sales volume within a relevant range. These are often projected based on current contractual obligations or slight adjustments for inflation. Variable expenses, however, fluctuate with the level of business activity, including sales commissions, packaging costs, or certain utility charges. These can be projected as a percentage of revenue or sales volume, similar to COGS.

Other income and expenses, such as interest income or interest expense on debt, are projected based on anticipated cash balances and outstanding loan agreements. Estimating taxes involves applying an assumed effective tax rate to the projected pre-tax income. For small businesses, consider self-employment taxes, which cover Social Security and Medicare, typically amounting to 15.3% on net earnings.

Assembling the Pro Forma Income Statement

Once all financial data points are projected, systematically assemble them into the traditional income statement format. This process translates the individual projections into a coherent financial narrative. Begin by placing the projected Revenue figure at the top of the statement.

Subtract the projected Cost of Goods Sold (COGS) from revenue to arrive at Gross Profit. Subsequently, all projected Operating Expenses, which include categories like Sales and Marketing, and General and Administrative costs, are itemized and deducted from the Gross Profit.

This deduction results in the Operating Income, reflecting the profitability of the core business operations. From the Operating Income, subtract any projected Interest Expense to determine Pre-tax Income. The final step involves calculating and subtracting the projected Income Tax expense from Pre-tax Income to arrive at Net Income.

Throughout this assembly, clear labeling for each line item is important, along with consistent formatting for currency and time periods, such as monthly, quarterly, or annually. Spreadsheet software is commonly used for this task, as it facilitates the systematic input of projected numbers and automates the calculations, ensuring accuracy and allowing for easy adjustments to assumptions.

Reviewing and Presenting Your Projections

After the pro forma income statement is assembled, review it to ensure logical consistency and reasonableness. This involves scrutinizing projected figures to confirm they align with underlying assumptions and contain no obvious calculation errors. Check if gross profit margins or operating expense ratios appear plausible given industry benchmarks and strategic goals.

Verify that the flow of calculations is correct, from revenue down to net income. Once validated, present the pro forma income statement clearly and concisely. Include a summary of the key assumptions that underpin the financial projections.