Creating a pro forma financial statement allows you to plan for and possibly avoid moments of financial vulnerability, instead of finding yourself immersed in debt problems too big to handle and too difficult to recover from.
By using this type of informal financial statement, you can be in control in the face of change.
Here is a brief explanation of a pro forma, how it can assist your small business and how it can keep you safe from debt.
What is a Pro Forma?
Translated from Latin, pro forma means "as a matter of form," and refers to financial statements that emphasize certain figures and operate based on assumptions. The data in a pro forma may include estimated expenses, positive cash flow and revenue projections.
Unlike historical financial statements, which follow generally accepted accounting principles (GAAP), pro forma statements are informal and hypothetical.
A pro forma focuses on uncertain projections rather than analyzing the past, and makes calculations based on assumptions instead of hard facts.
Additionally, a pro forma projection begins with information from current financials, uses those figures as a foundation and then accounts for possible future variables. This allows your business to have a comprehensive plan that uses both formal and informal types of statements to inform decisions.
Who Benefits from a Pro Forma?
Your business, your investors and your bank may all benefit from a pro forma.
The pro forma benefits the business by assisting with budgeting, planning and preparation for changes. These types of changes include your own salary, taking on different major customers, completing mergers or acquisitions, unique expenses for one-time projects, and new financing such as debt, stock, subsidies or grants.
Using a pro forma accounts for outliers—like unusual or non-recurring expenses—that do not accurately represent the overall financial trends and needs of a business. Adjusting a pro forma based on changes accounts for the dynamic environment of the market and allows you to consider various future endeavors along with the consequences of major decisions.
Banks and potential investors may request a pro forma to analyze assets, liabilities, income and expenses before providing capital.
How Can a Pro Forma Help Prevent Debt?
Debt often catches people off-guard. You don't have to be one of those people. By completing pro forma projections, you can prevent many problems ahead of time.
Pro forma statements, which forecast the future, reveal weaknesses and allow your business to make adjustments to its plans that will account for or avoid deficiencies.
Some of the most helpful pro forma statements are completed by using conservative estimates. You can accomplish this by projecting lower sales and income, and higher expenses and cash expenditures.
Also, recognizing where possible weaknesses exist forces businesses to streamline operations and ensure consistency, which will contribute to the long-term success of a business.
Debt can be the result of lack of preparation. A pro forma helps to avoid debt by considering all possible outcomes early on, saving your business from an unexpected crisis that could leave you frantically searching for immediate loans to continue functioning.
Debby McGrew writes for Debt.org, America’s Debt Help Organization. She hopes her contributions will help entrepreneurs make smart financial decisions.