How to Make Proforma Financial Statements

Proforma financial statements are forward-looking financial reports that project a company’s future financial performance. These statements serve as an important planning tool, offering a hypothetical view of future scenarios for various business strategies. Businesses utilize proforma statements for strategic planning, budgeting, evaluating potential investments, and securing funding. They are built upon assumptions about future conditions, providing a structured forecast rather than a historical record.

Understanding the Foundational Data

Creating proforma financial statements begins with gathering and analyzing foundational data. Historical financial information is a starting point, as past performance in revenue, expenses, assets, and liabilities often provides a basis for future trends. However, future projections are not simply extrapolations of the past; they are influenced by assumptions about future business activities and economic conditions.

Assumptions are central to any financial forecast, translating strategic objectives and market insights into quantifiable inputs. Common categories of assumptions include revenue growth rates, based on market research, sales pipeline analysis, or industry benchmarks.

Cost of Goods Sold (COGS) is projected as a percentage of revenue, reflecting the direct costs associated with producing goods or services. Operating expenses, such as salaries, rent, marketing, and utilities, are categorized as either fixed or variable. Fixed costs remain relatively constant regardless of sales volume, while variable costs fluctuate with production or sales levels.

Capital expenditures (CapEx) involve projections for acquiring or upgrading long-term assets like property, plant, and equipment. These projections require detailed planning, considering asset lifespans and strategic investments.

Working capital assumptions encompass current assets and liabilities, such as inventory levels, accounts receivable (money owed by customers), and accounts payable (money owed to suppliers). Forecasting these elements involves estimating their change in relation to projected sales and operational activities. Financing assumptions detail how the company plans to fund its operations and growth, including debt interest rates or equity contributions.

Finally, tax rates are incorporated into the assumptions. The federal corporate tax rate in the United States is 21%. These assumptions are sourced from internal records, market research reports, industry benchmarks, and broader economic forecasts, forming the data foundation.

Building the Proforma Income Statement

Constructing a proforma income statement begins with projecting future revenue. This involves applying an anticipated growth rate to historical sales or forecasting units sold by their projected selling price.

Following revenue, the Cost of Goods Sold (COGS) is projected. COGS is often estimated as a consistent percentage of the projected revenue, based on historical averages or anticipated changes in production costs. Subtracting the projected COGS from the projected revenue yields the gross profit, indicating profitability of core operations before overhead.

Operating expenses are then projected, distinguishing between fixed and variable costs. Fixed expenses, such as rent and administrative salaries, might remain constant or increase by a small percentage. Variable expenses, like marketing or sales commissions, are typically modeled as a percentage of revenue or per unit sold. Depreciation and amortization expenses are included here, calculated based on the useful life of existing and projected capital assets.

Subtracting total operating expenses from gross profit results in operating income, also known as Earnings Before Interest and Taxes (EBIT). This represents profitability from primary business activities. Interest expense is then calculated based on projected debt levels and assumed interest rates. Finally, projected income tax is calculated by applying the assumed tax rate to the taxable income. The remaining amount is the net income.

Building the Proforma Balance Sheet

Developing a proforma balance sheet requires linking projections from the proforma income statement and incorporating assumptions about asset, liability, and equity accounts. Current assets (e.g., cash, accounts receivable, inventory) are projected based on their relationship to sales and COGS. Cash, as a balancing figure, is often derived from the cash flow statement, linking the three core financial statements.

Non-current assets, like property, plant, and equipment (PP&E), are projected by taking the previous period’s balance, adding any projected capital expenditures, and subtracting accumulated depreciation from the income statement.

On the liabilities side, current liabilities such as accounts payable are projected as a percentage of COGS. Short-term debt changes are influenced by cash flow needs and repayment schedules. Non-current liabilities, including long-term debt, are projected based on new borrowings, scheduled principal repayments, and financing assumptions.

Equity accounts are updated by taking the previous period’s balance and adding projected net income from the proforma income statement. If dividends are planned, they are subtracted from retained earnings. The fundamental accounting equation, Assets = Liabilities + Equity, must always balance, providing an important check on the accuracy of the projections.

Building the Proforma Cash Flow Statement

The proforma cash flow statement connects the income statement and balance sheet by detailing the projected inflows and outflows of cash. It is structured into three main sections, beginning with cash flow from operating activities. This section starts with the net income projected on the proforma income statement, then adjusts for non-cash expenses like depreciation and amortization.

Changes in working capital accounts, derived from the proforma balance sheet, are then incorporated. Increases in current assets or decreases in current liabilities represent uses of cash, while decreases in current assets or increases in current liabilities represent sources of cash.

Investing activities detail projected cash flows related to the purchase or sale of long-term assets. This includes projected capital expenditures, representing cash outflows for acquiring new property, plant, and equipment. These figures directly link to the changes in non-current assets on the proforma balance sheet.

Financing activities capture cash flows from debt and equity transactions. This includes cash inflows from new debt issuance or equity contributions, and cash outflows for debt repayments or dividend distributions. The net change in cash for the period is then calculated by summing the cash flows from operating, investing, and financing activities. This net change is added to the beginning cash balance to arrive at the ending cash balance, which must reconcile with the cash balance on the proforma balance sheet.

Interpreting and Applying Proforma Statements

Once proforma financial statements are built, the next step involves analyzing the projected financial performance. This analysis helps identify potential trends, assess the company’s projected financial health, and evaluate metrics such as liquidity, solvency, and profitability. Examining projected profit margins, for instance, can indicate the efficiency of future operations.

Proforma statements are also useful for scenario planning, allowing businesses to test various assumptions. By creating “best-case,” “worst-case,” and “most likely” scenarios, companies can understand the range of potential outcomes and the sensitivity of their financial results to changes in variables. This process provides insights into potential financial risks and opportunities.

The insights gained from proforma statements directly inform strategic decisions. They can guide choices related to securing funding, evaluating new projects, developing budgets, and setting performance targets for future periods. For example, projected cash flows can highlight potential funding gaps, prompting proactive measures to arrange financing.

Proforma creation is often an iterative process, meaning adjustments are made as new information or insights become available. The initial projections serve as a baseline, which can be refined over time to improve accuracy and reflect evolving market conditions or business strategies. This approach ensures that the financial forecasts remain relevant and useful for ongoing planning and decision-making.