Utilizing prospective and pro forma financial statements to visualize the “what ifs” for your business…
Financial statements are an invaluable tool for any business. They provide a wealth of information about an enterprise’s financial position and performance—data that is instrumental in the decision-making of both company management as well as third parties with a vested interest in the organization (e.g., lenders and investors).
While there is no question regarding the usefulness of financial statements, it is important to note they are based completely on historical information—the results of what has already happened. Imagine how beneficial it would be to expand on that historical information: to see potential financial results based on what could have happened or has yet to happen; to answer the “what if” questions regarding your organization or possible business investments. Well, stop imagining and start utilizing prospective and pro forma financial statements to help you visualize the “what if” to supplement your basic financial statements.
Prospective and pro forma financial statements both serve a unique and specific purpose that functions as a valuable tool when evaluating the potential impact your decisions will have on your business in the future.
Prospective Financial Statements
The unique characteristic of prospective financial statements is the use of assumptions regarding future events, based on a combination of historical information and the intentions of management. By nature, prospective financial statements embody many assumptions, some of which are more significant or sensitive than others. An assumption is considered sensitive if it has a high probability of changing in the future and the resulting change would materially affect the prospective financial statements. Because we cannot foresee the future—and because it can be impacted by factors both internal and external to a business—it is important to understand the inherent limitations.
There are many reasons why you may want to issue prospective financial statements. Perhaps you want to obtain additional financing and need to present forward-looking financial information to accompany a business plan. Maybe you are considering a change in operations and want to ascertain the potential impact this change could have on your future cash flows or ability to satisfy loan covenants. In essence, prospective financial statements provide either financial forecasts or financial projections that present, to the best of the responsible party’s knowledge and belief, an entity’s expected financial position, results of operations and cash flows.
Pro Forma Financial Statements
Pro forma financial information is presented when an entity wants to show what the direct and significant effects on its historical financial statements might have been had a major transaction or event taken place at an earlier date. Although this appears to be a prospective, pro forma presentations are essentially a recast of historical financial statements. Generally, the historical financial statements to which the pro forma financial information relates are presented with the pro forma statements or are readily available.
A couple key distinctions for the preparation of pro forma financial statements are: a) The assumptions used need to be within the realm of possibility; and b) The pro forma financial statements should be based on a limited number of assumptions. (The preparations of pro forma financial statements based on too many assumptions become prospective financial statements.)
Pro forma financial statements may be presented for many scenarios, including to show the effects of a business combination or what the impact of a new lease accounting standard would have been had it been implemented in the previous year. Fundamentally, they are prepared to show the financial statements of an entity in a yet-to-be-realized hypothetical scenario, or to present a modification to an entity’s historical financial statements.
Both prospective and pro forma financial statements provide businesses the opportunity to present futuristic financial information that can be used to enhance the usefulness of their current historical information. Additionally, these reporting alternatives allow organizations the flexibility in what, and how much, information is presented. Armed with one of these variations on historical data, you and other users of your financial information may be better poised to develop, implement or invest in current or new business initiatives.
When you review your current set of historical financial statements, think about how presenting a projection or pro forma financial information could provide you with more data to positively impact the future success of your business. Reach out to your accountant, and move from imagination to realization. iBi
Jennifer L. Goettler, CPA, CFE is a shareholder and head of Heinold Banwart, Ltd.’s Audit Services Department. She can be reached at (309) 694-4251 or [email protected].