The Pro Forma Statement: Projecting the Future
For small-business owners tracking their own finances, forecasting the future is just as important as accurately documenting the past. Developing a pro forma statement is invaluable for every forward-thinking entrepreneur. Pro forma statements are financial projections of income and cash flow used when considering what-if scenarios, formulating business plans, and managing anticipated changes. With the historical knowledge of past performance in mind and a careful eye on current trends in the industry, revenues and expenses can be accurately estimated to plan for growth and gain profitable investors. To start you on the road to projecting your future success, here are a few tips to consider when drafting your pro forma statement.
1. Analyze past and present trends
Analyzing trends is essential to the creation of an accurate pro forma statement. This involves calculating an average growth rate based on past results and applying the rate to revenue and expense line items. Previous sales and expense data can accurately support future projections. For further assistance, try implementing a cloud-based accounting system to capture financial performance. If possible, examine previous up and down cycles, and look at monthly data for seasonality.
2. Consider known future events
If there is a known event on the horizon that will affect future finances, it should be included in your pro forma statement. For example, the acquisition or loss of a large customer will undoubtedly impact sales. If no future income is expected, remove the associated receivables and expenses from future trends. If your business needs to invest in technology to keep up with competitors, include a price quote in your pro forma to accurately determine the increase in expenses your company will face in the coming year.
3. Research external factors
Prior to drawing up projections, spend time researching your industry's environment and consider how external factors might impact business growth in the coming years. Tax changes, legislative rulings, and vendor buyouts can all affect a company without any change to internal operations.
4. Draft conservatively
When external parties, such as bankers or investors, rely on pro forma statements, the estimations should be well-supported and conservatively applied. For example, consider the lowest amount of growth observed in recent years and the largest expected increase in expenses. Run a set of financials incorporating worst-case scenarios and compare them to more reasonable expectations. Determine how far off the worst case is from current expectations, and decide if changes need to be made to your business plan. Alternatively, some small businesses provide multiple pro forma statements, incorporating different levels of growth to illustrate a range of potential performance.
5. Forecast from day one
Pro forma statement preparation can be challenging prior to the launch of a business. Potential investors may request to see projected finances as a part of an overall business plan. When compiling financial statements without the benefit of past performance data, assumptions may be based on similar companies. If data is not publicly available, a small business development center (SBDC) can assist with compiling a plan. Demographic information and population projections available from the U.S. Census Bureau can also help formulate a potential customer base. Similarly, the Bureau of Labor Statistics provides consumer spending information based on location and household income to help new small-business owners build assumptions.
Pro forma financial statements are an essential part of any company's strategic plan. Whether the business is well-seasoned or in its infancy, taking the time to model assumptions and examine trends can greatly improve the accuracy of future financial projections.