What is Pro forma?
Pro forma, a Latin term meaning “as a matter of form”, is a set of financial statements prepared using hypothetical transactions or scenarios. They are most commonly used to show a company’s financial statements including the effects of a planned M&A deal, however, they can also be used in other scenarios.
Businesses use pro forma statements for decision-making in planning and control, financial transactions, and external reporting to investors and creditors.
Investors and creditors often use pro forma statements to help understand the planned actions of management. Comparison of pro forma and actual financial statements can help them to appraise whether these planned actions are in their best interest.
Key Learning Points
- Pro forma financial statements are prepared using hypothetical scenarios – they are often used to show the effects of an M&A deal on a company’s financial statements.
- Pro forma statements are used in both external reporting and internal business and financial planning.
- Pro forma statements are not required to adhere to GAAP standards and are unaudited. They can be issued to the public where the information is useful to investors.
- The format of pro forma financial statements is similar to the format of historical financial statements. The main difference lies in the assumptions and adjustments used in their preparation.
Documents in Pro forma Financial Statements
There are three main documents in pro forma financial statements:
- Pro forma income statement: shows the revenues and cost of the business adjusted to include the effects of a hypothetical transaction. In the context of a business acquisition, this will include both the acquirer and target company’s revenues and costs for the latest financial year.
- Pro forma balance sheet: provides a snapshot of the company’s assets and liabilities, adjusted to include the effects of a hypothetical transaction. A pro forma balance sheet may be more summarized than a company’s actual balance sheet.
- Pro forma cash flow statement: shows the cash inflows and outflows adjusted to include the effects of a hypothetical transaction.
Example of pro forma income statement
Below is an example of a pro forma income statement of Amazon.com, Inc for the year ended December 31, 2017. The regular income statements reflect the exact income figures a business generated in past years. The pro forma income statement includes the expected effects of a planned business acquisition.
Example of pro forma balance sheet
Below is an example of pro forma balance sheet of Airbnb, Inc, for the financial year ended September 30, 2020. The pro forma column in the consolidated balance sheet reflected a planned capital restructuring following its initial public offering.
Example of pro forma cash flow statements
Below is an example pro forma statement of cash flows in Lloyd’s Preliminary Results 2020.
The true value of pro forma statements goes beyond the numbers they show. Management uses pro forma analysis in the decision-making process when constructing an annual budget, developing long-range plans, and choosing among capital expenditures. Investors use pro forma analysis to appraise the plans and decisions of management.
However, there are limitations to pro forma financial statements – particularly for investors. Since these documents are based on management assumptions, do not adhere to GAAP, and are unaudited statements, they should be relied upon with caution.