Pro Forma Financial Statements & Project Cash Flows

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  • 0:00 Pro-Forma Financial Statements
  • 1:13 Pro-Forma Balance Sheet
  • 2:23 Pro-Forma Income Statement
  • 4:36 Pro-Forma Statement of…
  • 5:46 Lesson Summary
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Lesson Transcript
Instructor: Tammy Galloway

Tammy teaches business courses at the post-secondary and secondary level and has a master's of business administration in finance.

In this lesson you'll learn about pro-forma financial statements and how to estimate specific line items on the balance sheet, income statement, and statement of cash flows. We'll also discuss the difference between pro forma and GAAP.

Pro-Forma Financial Statements

Jack is a director of financial analysis for Juicy Hot Dogs (JHD), the largest hot dog chain in the U.S. His boss, the chief financial officer, Susan, privately shares with him that JHD may purchase the second largest hot dog chain, Doggie Dogs. If the acquisition were to be finalized, JHD would be the largest hot dog chain in the world!

Susan tells Jack she needs him to prepare pro-forma financial statements to determine the profitability of the purchase. Pro forma is a forecast or estimate of financial statements. She mentions that following GAAP is not required in preparing pro-forma statements. GAAP is an acronym for generally accepted accounting principles, which are common standards publicly traded companies must follow. GAAP is used to ensure investor confidence. Susan explains to Jack that while she wants the statements to be as accurate as possible, they are to be used internally to make an acquisition decision. Pro-forma statements are created when there's an anticipated change in the company's circumstances.

Jack travels to Doggie Dogs' headquarters to review their financials and create a pro-forma balance sheet, income statement, and statement of cash flows.

Pro-Forma Balance Sheet

Jack meets with a senior accountant who shows him the balance sheet first. A balance sheet is a financial statement that portrays a company's financial position. It's considered a snapshot in time since it's not a consolidation report of weeks, months, or quarters.

The components of a balance sheet are assets, liabilities, and equity. Assets are items the company owns, which include cash, buildings, semi-trucks, and investments. Liabilities are obligations owed to others, such as suppliers. Other liabilities include the loans on the semi-trucks and buildings.

The difference between assets and liabilities is equity. Equity represents shareholder ownership. Shareholders are investors who have purchased stock, or a percentage of the company.

Jack's job is to create a year-end pro-forma balance sheet. He asks the accountant several questions:

• Does Doggie Dogs have any outstanding contracts to purchase assets?

• Do they plan to sell any investments?

• What are their plans to pay off obligations by the end of the year?

• Estimate the last five years of stock purchases in the final quarter of the year.

The answers to these questions will assist Jack in completing a pro-forma balance sheet.

Pro-Forma Income Statement

An income statement shows a company's profitability by taking revenues minus expenses.

Revenues are sales. Revenue on pro-forma statements is calculated based on events such as a competitor going out of business, which will increase sales by 20%, or a new competitor coming on the market, which will decrease sales by 10%. Other factors can affect sales, including seasonality, marketing, customer service, and new product launches.

Expenses are the costs of doing business. Examples of Doggie Dogs' expenses include restaurant workers' wages, utilities, and their cost of goods sold (COGS). Costs of goods sold are the costs a business incurs to purchase the product they are selling. Doggie Dogs does not make hot dogs or buns, they purchase them from a supplier. Therefore, these two costs are listed as COGS. Other expenses include selling, general and administrative costs, utilities, and insurance.

It's important to note that expenses can be fixed or variable. Fixed expenses, such as automobile insurance, do not change based on sales. Whether Doggie Dogs sells $1 million or $100,000, their automobile insurance remains the same. On the other hand, variable expenses change with a change in sales. For example, utilities may increase substantially in the summer for Doggie Dogs since their sales increase due to picnics, family reunions, and vacations.

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