Pro forma balance sheets serves many purposes. Small businesses create pro forma balance sheets to show investors or lenders the predicted future income or profitability of the company. Alternatively, a large company may develop a pro forma balance sheet to show board members or shareholders how the company is forecast to do in future fiscal years.
What is a Pro Forma Balance Sheet?
A pro forma balance sheet discloses all of a company's liabilities and assets at a designated point in time and uses these numbers to predict how the company will do in the future. When creating the pro forma balance sheet, a business may choose to include or exclude outside factors that may affect the business. For example, a pro forma balance sheet may include future costs of products or services or current costs. Pro forma balance sheets are not recognized as financial statements in accordance with Generally Accepted Accounting Principles, or GAAP.
Benefits of Pro Forma Balance Sheets
Pro forma balance sheets benefit businesses in a multitude of ways. First, a small business owner can examine a pro forma balance sheet and see clearly how the business is most likely going to perform in one, five, or ten years ahead of time. A pro forma balance sheet is a great tool to show a small business owner or investor what money is tied up in a business' assets or inventory. The small business owner can then make adjustments to the business to make it more profitable based on the predictions. Pro forma balance sheets also allow a small business owner to see areas of the business that need improvement or will be affected by changing conditions. For example, a pro forma balance sheet can be used as a tool to show the financial soundness of the business. Pro forma balance sheets also show small business owners how a new business venture or product will change the profitability or assets of the business. In addition, a pro forma balance sheet lets small business owners manipulate assets and potential products to come up with the best plan for their business.
In the past, businesses were manipulating pro forma balance sheets to show that the business was profitable, when in fact the opposite was true. In reaction to this phenomenon and other securities activities, the federal government passed the Sarbanes-Oxley Act. Now, a business cannot intentionally mislead an investor by using a pro forma balance sheet. In addition, since the pro forma balance sheet is not created in compliance with GAAP, the United States Securities and Exchange Commission requires that businesses disclose this to investors and make available the business's GAAP financial statements.