What are the steps in preparing pro forma financial statements?
PREPARING PRO FORMA FINANCIAL STATEMENTS
The preparation of pro forma financial statements requires the analyst to make assumptions about the future. The usefulness of the pro forma financial statements depends on the reasonableness of those assumptions. Various computer spreadsheet programs ease the calculations required in preparing these statements, but the warning "garbage-in, garbage-out" certainly applies—the results will have quality and validity no better than the input assumptions. Careful analysts bring together, preferably in a single section of their spreadsheet, a list of all assumptions made. Well-prepared pro forma statements allow the analyst to vary critical assumptions to see how the results vary.
The preparation of pro forma financial statements typically begins with the income statement, followed by the balance sheet and then the statement of cash flows. The level of operating activity usually dictates the required amount of assets, which in turn affects the required level of financing. Amounts for the statement of cash flows come directly from the pro forma income statement and comparative balance sheets.
The following are the steps in preparing pro forma financial statements:
1 . Project operating revenues.
2 . Project operating expenses other than the cost of financing and income taxes.
3 . Project the assets required to support the level of projected operating activity.
4 . Project the financing (liabilities and contributed capital) required to fund the level of assets in step 3 .
5 . Project the cost of financing the debt projected in step 4, income tax expense, net income, dividends, and the change in retained earnings.
6 . Project the statement of cash flows from amounts on the projected balance sheet and income statement.
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