Pro Forma Statements
We reviewed the complexities of creating a strategic plan for the business. By definition, strategy is a forward-looking process that considers where the company wants to be and what it will take to get there. The same applies to preparing future financial forecasts or pro formas. This chapter covers the process for determining future financial performance. It is important to understand the use of common sizing and the percentage of sales methods.
Learning Objective |
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Pro forma statements are to be tools to help a company plan for the future. They are only as good as the assumptions upon which they are constructed.
Our analysis has been straightforward and simple but it can get more complex. Companies can change many of the other variables found on their income statements and balance sheets. Companies determine their dividend policy (which influences retained earnings) and they can influence their level of debt (through their capital structure decisions which influences their interest expense) as well as their common stock.
Now we have constructed our pro forma statements. But how accurate are they? What's the probability that our pro forma will correctly depict our company's future? To answer this question, pro formas can be analyzed using scenario analysis, which we cover in more detail in chapter 13. Companies can analyze best, worst, and most likely case scenarios by creating sets of pro formas with different underlying assumptions. This might seem like a lot of work, but spreadsheets can make these calculations fairly easily.
Pet Products Forever estimates that their most likely case is an increase in sales of 10%. Their best case would be an increase of 20% and their worst case would be an increase of 2%. Remember that COGS are % of sales and SG&A are % of sales.
The best case results in net earnings of $13 thousand, while our worst outcome is $9.4 thousand. The company is still doing well, even under the worst case scenario. Not a bad result!
Key Takeaways |
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