32. Pro Forma Financial Statements

Question 1

What are pro forma financial statements?

Answer 1

Pro forma financial statements provide a view of the organization’s future financial performance based on current financial statements and anticipated future actions. The term pro forma essentially means “as a matter of form.”

Question 2

Describe the process of preparing pro forma financial statements using the percentage-of-sales method

Answer 2

1. Grow sales revenue by a growth measure determined by a specific strategy.
2. Establish which types of expenses and balance sheet accounts that are expected to function as a percentage of sales revenue.
3. Make individual projections for the remaining accounts.

Question 3

How is the pro forma balance sheet used to determine debt financing needed?

Answer 3

The pro forma balance will determine whatever financing is needed to support the planned level of assets using the following equation:

Projected total assets – Equity – Remaining liabilities = Balancing debt account

The current amount of debt will be subtracted from the balancing debt account to calculate the increase or decrease in debt financing needed

Question 4

Describe the relationship of changes in balance sheet accounts with changes in the cash account.

Answer 4

1. Increases in debt (liability) accounts or equity accounts result in increases in the cash account.
2. Increases in asset accounts (all asset accounts other than cash) result in decreases in the cash account.
3. This can be depicted as follows: ∆ Cash = ∆ Debt + ∆ Equity − ∆ Assets

Question 5

How are changes in cash flow classified across the three categories of the cash flow statement: cash from operating activities, cash from investing activities, cash from financing activities?

Answer 5

1. Cash flows from operating activities are based on balance sheet accounts for current operating assets and current operating liabilities.
2. Cash flows from investing activities are based on balance sheet accounts for current non-operating assets and long-term assets.
3. Cash flows from financing activities are based on balance sheet accounts for current non-operating liabilities, long-term liabilities, and equity.

Question 6

How are financial ratios used to ensure pro forma financial statements meet the organization’s goals?

Answer 6

Most organizations have specific goals, lender requirements, and investor expectations, regarding financial statement performance as captured by various types of financial analysis ratios. These financial analysis ratios are calculated using pro forma financial statement information to determine if the organization can plan to achieve its financial performance objectives.