The pro forma financial statements are often prepared in advance of major transactions that are prearranged. Some of the transactions that require pro forma financial statements are starting of a business, capital investment projects, alteration of the capital structure of the business, acquisition, and merger among other factors. The pro forma financial statements are quite similar to financial projections since they have similar objectives. In most cases, these projections are commonly prepared for a startup company. The preparation of the pro forma financial statements is ideal when aligned to reliable and objective data information. This will enable the company owners to come up with accurate profits of the organization and the financial needs of the organization within the period of forecasting (Bangs, 2002).
The pro forma financial statements help businesses in a number of ways. First, startup companies need the pro forma financial statements for decision making. Specifically, the statements aid in planning for available resources. It aids the management in allocating the resources available to different functions within the organization. Further, pro forma financial statements aid in control tool for a startup company. An organization will be able to measure results of performance of the business against the estimates in the pro forma statements. This enables the organization to identify variances that arise and their causes. Hence, the organization will be able to correct the cause of the variances and enable the organization move on the right track. Also, the pro forma financial statements will form a good basis for reporting the future results of the organization to various stakeholders of the organization. This statement provides the means for the analysts to carry out ifromed comparative reporting and review of exiting or even new organizations. They will also be able to provide a feel of the nature of the new business and how the business will respond to various business conditions. Also, it forms a basis for calculating various financial ratios. The pro forma statements are prepared after a comprehensive assessment of risk in the organization. Thus, the managers of the organization will be able take into all the risks that are related to starting and running of an organization. Further, the pro forma financial statements will aid a new company to acquire both debt and equity. It is because the capital providers will be able to evaluate the financial viability and profitability of the business (Shelters, 2012).
Finally, the pro forma financial statements enable the managers of the new business to test the relationships of the new business by studying the effect of changes of various variables such as the amount of sales, selling prices, borrowing interest rates, cost of sales, administrative, selling and distribution expenses, and inflation on the new company. It enables the management to carry out sensitivity analysis. The analysis provides information on the performance of a business in a worst case and the best case scenario (Kuratko, 2008).
The financial projections in the pro forma statements are based on a number of assumptions. First is the assumption about the financial and operating features of the business under different scenarios. Secondly, the projections are based on the objectives of the owners and what they intend to achieve within a given period of time. Thirdly, the financial projections are often based on the financial results of business within the same industry because it provides vital information (Shelters, 2012).
References
Bangs, D. (2002). Business Planning Guide. New York: Kaplan Publishing.
Kuratko, D. (2008). Entrepreneurship: Theory, Process, Practice. USA: Cengage Learning.
Shelters, D. (2012). Startup Guide for the Technopreneur: Financial Planning, Decision Making and Negotiating from Incubation to Exit. USA: John Wiley & Sons.