Prospective Financial Information Explained
Gain insight into how financial statements are prepared for the future, based on either expected conditions or hypothetical "what-if" scenarios.
Prospective financial information (PFI) represents a forward-looking view of an entity’s expected financial position and performance. Unlike historical financial statements that report on past events, PFI is built on assumptions and judgments about future events and actions. This information is a tool for internal management functions, such as strategic planning, budgeting, and evaluating potential new ventures.
Beyond internal use, PFI is often prepared for third parties. A business seeking a loan from a bank, attempting to attract investors, or negotiating the sale of the company will need to provide forward-looking financial data, which allows external stakeholders to assess the company’s future viability and potential return on investment.
Types of Prospective Financial Information
A financial forecast is a form of PFI that presents an entity’s expected financial position, results of operations, and cash flows. It is based on the responsible party’s assumptions about conditions they expect to exist and the course of action they expect to take. These assumptions are rooted in past performance, current conditions, and planned operational strategies. Because a forecast represents what is considered the most likely scenario, it is deemed appropriate for “general use,” meaning it can be distributed to parties who are not directly negotiating with the company, such as stockholders or potential investors.
A financial projection is based on hypothetical, or “what-if,” assumptions. It shows a potential financial outcome based on a specific course of action that the company is not necessarily expected to take, such as launching a new product line or acquiring a competitor. The use of hypothetical assumptions means a financial projection is restricted to “limited use.” Its distribution is confined to the responsible party and the specific third party for whom it was prepared, as a user unaware of the underlying hypothetical assumptions could be misled.
Key Elements of a PFI Presentation
A PFI presentation must include a set of prospective financial statements that mirror historical statements, including a prospective balance sheet, income statement, and statement of cash flows. A summary of significant assumptions is also required, disclosing the key assumptions upon which the financial figures are built. For a projection, the summary must also explicitly identify the hypothetical assumptions and describe the “what-if” scenario.
The PFI presentation must clearly identify the responsible party, which is the management of the entity, clarifying accountability for the entire presentation. Other disclosures include a statement of the purpose for which the PFI was prepared. A cautionary statement is also required, warning users that the prospective results are not guaranteed as they are based on assumptions about future events that are inherently uncertain.
Practitioner Engagement Options
An examination is the highest level of service a Certified Public Accountant (CPA) can provide on prospective financial information. In this engagement, the practitioner conducts a thorough review, performing various procedures to gather evidence about the PFI. The objective is to provide an opinion, or positive assurance, on two matters: whether the underlying assumptions provide a reasonable basis for the PFI and whether the PFI presentation conforms with AICPA presentation guidelines. This service is often sought when PFI is intended for third-party use, such as in connection with securing significant financing or for an investment prospectus.
A compilation engagement is substantially less in scope than an examination. Here, the practitioner’s role is to assist management in presenting the financial forecast or projection in the proper format. The CPA reads the PFI and checks for obvious errors in the application of accounting principles and the compilation of the data, but they do not perform procedures to evaluate the reasonableness of the underlying assumptions. The report issued for a compilation provides no assurance and explicitly states that the practitioner has not examined or reviewed the PFI and does not express an opinion.
An agreed-upon procedures engagement offers a flexible and targeted approach. In this service, the practitioner is engaged by a client to issue a report of findings based on specific procedures performed on the PFI. These procedures are agreed upon by the practitioner, the responsible party, and any specified third parties who will use the report. For example, a lender might ask a CPA to perform specific procedures to verify projected sales figures or cash collections.
The practitioner’s report on an agreed-upon procedures engagement does not provide an opinion or overall assurance on the PFI. Instead, it lists the procedures performed and the factual findings from those procedures. Users of the report are responsible for drawing their own conclusions based on the reported findings.