What is Pro Forma?

Pro forma refers to a set of financial statements that incorporate assumptions or hypothetical conditions regarding past or future events. Pro forma statements are useful for presenting possible financial results, but must be viewed with caution if the underlying assumptions are not valid or not likely. They are typically targeted at potential or existing investors in a business.

The Pro Forma Invoice

An alternative use of the pro forma concept is the pro forma invoice. This is a preliminary version of an invoice that contains the items being sold, their prices, and any other relevant information. It is sent to the buyer when an order is placed. The pro forma invoice is the seller’s best estimate of what a product will cost, and is a useful way to prevent any pricing disputes when the sale transaction is eventually finalized.

Example of Pro Forma Statements

As an example, pro forma statements can be constructed that extend an entity's financial statements through the end of its current fiscal year, containing assumptions regarding the final months of the year that have not yet occurred. Similarly, pro forma statements can include the results of a recent acquisition as though it had occurred earlier, as of the beginning of the year. In both cases, the intent is to provide readers with a best guess about what a full year of financial results would look like, given the presence or absence of certain events.

Limitations of Pro Forma Financial Statements

Pro forma financial statements are useful tools for projecting future financial performance, but they come with limitations. Here are some key limitations of pro forma financial statements:

Reliance on assumptions. Pro forma statements are built on assumptions about revenue, expenses, interest rates, and other factors that may not accurately reflect real future conditions. Changes in these variables can cause significant deviations from projected outcomes.
Limited reliability. Pro forma financial statements are more reliable for short-term projections but tend to be less accurate for long-term planning. This is because it’s difficult to account for changes in market conditions, competition, regulations, and other external factors over extended periods.
May exclude non-recurring items. Often, pro forma statements exclude non-recurring expenses or revenues (such as restructuring costs or gains from asset sales) to focus on core business performance. However, such items can still have a meaningful impact on the company's cash flow, liquidity, and overall financial health.
Potential for bias. Management might prepare pro forma financial statements to support a narrative, such as making a merger or acquisition appear more favorable. This bias can distort financial projections to influence stakeholders.

In summary, while pro forma financial statements can be valuable for scenario analysis and forecasting, they should be interpreted cautiously. Decision-makers and stakeholders need to understand the assumptions and potential biases that may impact the reliability of these projections.