Accurate Projections – Use Pro Forma Statements
As a key decision maker in your business, let’s say you decide on setting a goal for the year of a 10% increase in sales or a 5% increase in net income. To achieve that objective is not as easy as you might think. There are numerous factors to take into account in order to increase sales or increase revenue. Numerous factors come into play if your objective is to decrease operational expenses or decrease cost-of-goods-sold. Utilizing pro forma statements can help you reach your company’s financial targets. Pro forma statements make it possible for you to specifically identify what changes or returns to specific line items in your company’s financial statements need to be addressed. For example, you will realize that in order to increase sales, your company will need to increase production. Does your company have the capacity to achieve your sales goal?
Pro forma statements are used routinely in preparing ‘what if’ scenarios, formulating business plans, estimating cash requirements, or submitting financing proposals. Pro forma statements are also referred to as projected statements. Projected or estimated financial statements attempt to present a reasonably accurate idea of what a firm’s financial situation would be if present trends continue and/or certain assumptions hold true.
For example, a pro forma income statement is similar to a historical income statement, except the statement projects the future rather than track the past. If the projections predict a downturn in profitability, then you can make operational changes, such as increasing prices or decreasing costs, before these projections become reality.
Pro forma income statements provide an important benchmark or budget for operating your business throughout the year. For instance, pro forma income statements can project whether expenses can be expected to run higher in the first quarter of the year than in the second. These statements have the capacity to show whether sales can be expected to run above average in, let’s say, June. You may then decide your marketing campaigns need an extra boost during the fall months. All in all, you are provided with invaluable information—the sort of information you need to make the right choices for your business.
Assume that you expect sales to increase by 10 percent next year. You multiply this year’s sales volume of $1,000,000 by 110 percent to get $1,100,000. Then, in this case, you assume there will be no increase in the cost of each item you are selling, however you will need 10 percent more items to sell in order to achieve your sales goal. So, you multiply this year’s cost of goods sold (let’s assume a figure of $500,000) by 110 percent to realize a gross profit of $550,000.
Want to project your pro forma gross profit for next year? Subtract the pro forma cost of goods sold from the pro forma sales. Take the hypothetical $1,100,000, and subtract $550,000. The difference equals your gross profit, or $550,000.
This is, of course, a very simple example. What you really want to do is take into consideration everything possible to project sales. Are you going to launch new products? Introduce new promotions? Change pricing? Acquire new customers? All of these questions/factors should be carefully analyzed when creating sales projections.
In the next installment, we will examine using pro forma statements to calculate your company’s profit after taxes. Stay tuned!Tweet