What Is a Pro-Forma Forecast?
A pro-forma forecast is a financial forecast based on pro-forma income statements, balance sheets, and cash flow statements. Pro-forma forecasts are usually created from pro-forma financial statements and are forecasted using basic forecasting procedures. When making these forecasts, revenues will usually provide the initial groundwork for the forecast, and expenses and other items are calculated as a percentage of future sales.
Key Takeaways
- A pro-forma forecast is a financial forecast based on pro-forma financial statements.
- The pro-forma forecast is intended to show the improved financial condition of a company if a beneficial change takes place.
- Pro-forma forecasts do not have to abide by generally accepted accounting principles (GAAP) rules.
- As pro-forma forecasts are hypothetical in nature, they can deviate from actual results, sometimes significantly.
Understanding a Pro-Forma Forecast
Pro-forma financials used in the pro-forma forecast will usually reflect the predicted state of the business after a large or important transaction has taken place. The inclusion of anticipated future events in the pro-forma financial statements allows the company a unique opportunity to sculpt the presentation of the company's financial situation in a way that normally wouldn't be allowed under generally accepted accounting principles (GAAP) rules.
Often, events depicted in the pro-forma financial statements have yet to occur, so the actual financial picture of the company may be very different from the picture presented. Forecasts made from these financial statements may or may not contain an even higher degree of deviation from the actual state of the company.
A pro-forma forecast, similar to any sort of pro-forma report, is not required to abide by GAAP. As a result, they often reflect the best-case scenario, which the firm would like to portray to investors. It takes a skilled analyst to unpack the marketing from the actual numbers. Of course, the analyst can always just use the audited financial statements in their analysis as opposed to pro-forma statements and forecasts; however, these forecasts can be a valuable clue as to how the company intends to increase its value and what type of growth they are aiming for.
Example of a Pro-Forma Forecast
For example, XYZ Company is a publicly-traded maker of widget presses. After many years of research and development (R&D), they have applied for a patent on a new type of widget press technology. If they are granted the patent, they will be the only company that can use this new technology for 10 years. This new technology will allow XYZ Company to manufacture widget presses at half their current cost and several times more quickly. This could potentially make them the preferred provider in the space and help them gain market share.
To demonstrate this potential good fortune on the company's financial statements, XYZ Company may draw up pro-forma financial statements that show the predicted effects of lower costs and increased sales on the company's financial situation. Pro-forma forecasts made off of the assumption that this patent will be granted might show larger than normal yearly sales increases as XYZ Company steals market share from its less technologically advanced and more expensive competitors. Of course, if the patent isn't granted, all of this would be highly inaccurate.
