How to Create a Pro Forma Income Statement (2023)

A pro forma income statement is a financial statement that helps create the company’s financial projections. It is often used to help companies decide how much money they will need to grow or expand. It holds great importance in the startup stage because it helps investors and business owners know how much money they will make in the future and how to pivot their business plan to bring on potential investors.

A pro forma income statement can also help you see how your company would perform after an acquisition, merger, or other significant events.

This statement typically includes the following.

Net Income

The first thing to include is your company’s net income. By net income, I mean adding up all streams of wealth for your company and subtracting all expenses involved. For instance, you might have a building that generates revenue through rent. So, the rent is one income stream. Now suppose it has a laundry machine that also generates income. In addition, a shop or vending machine inside the building adds to the income. Moreover, mail service is another income stream.

So, combining these incomes gives us the net income of your business.

Depreciation

Another aspect to include is depreciation. Depreciation means the loss of value. For instance, in the beginning, your building was new with new furniture, colors, and other amenities. With time it got old, and now its value/rent has decreased. This is depreciation. Ensure that you take depreciation into consideration. Luckily, if we are using the example of real estate depreciation can be taken against your taxes and decrease your tax liability so it should be a part of your planning process.

Interest Expense

You have taken loans for the construction of the building, and now you are paying monthly installments with interest. So, the interest included in installments is interest expense. Some of your revenue is going there monthly. It will reduce the net income and should be included with the financial data of the current year.

Taxes

Taxes are another vital element while creating a pro forma income statement. Since taxes will affect your annual revenue, you can’t ignore them while calculating revenue. You have to subtract it from gross revenue. The first step is to look at what you think your taxes will be like, and work with a tax professional to determine how close you are. Taxes can make or break a company, so it is important to take them seriously when creating financial documents.

Other Noncash Charges (such as amortization)

It would be best if you didn’t forget other noncash charges such as asset impairments, stock-based compensation, and amortization. For example, most tech companies include reserved stock units (RSUs) or stock options for their employees as part of their compensation package. These usual noncash expenses decrease profitability but do not affect cash flows. However, they must be considered while predicting the future of any business.

Nonoperating Income (such as interest)

Nonoperating income refers to the revenue coming from other sources than the main business. For instance, as a real estate investor, you are huge into the house hacking method and you rent rooms in your home on Airbnb to lower your overall housing expense. The profits from renting out those rooms you have invested that money in stocks and also have started to be a private lender for a number of real estate deals. When you receive dividends or interest on that money, that is nonoperating income because it is income that is being generated not from the core business entity.

Nonoperating Expenses (such as depreciation)

These are expenses not explicitly related to your business. Let's say that you are running a real estate investment company. Your company could spend a decent amount of money in legal fees trying to evict a tenant. Your fictional real estate investment company is using leverage to purchase real estate so all the interest that is paid to service the debt the company is carrying is also a nonoperating expense. If your company goes through rapid growth, and you need to restructure that would also fall under nonoperating expenses. As you can see there are many nonoperating expenses, and you should remember nonoperating expenses while structuring a pro forma income statement.

Defining a Pro Forma Statement

A pro forma statement is a financial statement that provides the projected revenues, expenses, and net income for a company.

It is a projection of the company’s earnings for the next fiscal year. So, it is an estimate of what could happen in the future. The pro forma statement also shows how it might change or grow if there are any changes in assumptions, such as new products, new customers, or new markets.

It differs from an actual balance sheet because it contains estimates instead of numbers.

There are four main types of pro forma statements. These include financial information that is beneficial to project different scenarios and financial models. They include the following.

• Pro forma total expenses. This projection is used to estimate how operating expenses will change for the next year. This could estimate that cost of labor is going to increase three percent next year and then can be used to see if the financial results of the labor provided are worth the increase in cost. This helps plan out worst-case scenarios for the following year and beyond.
• Pro forma cash flow statement. The pro forma statement of cash flow displays the financial modeling of your outflows and inflows of cash across a designated time frame.
• Pro forma balance sheet. This is most similar to a balance sheet but serves a different purpose. It shows cash flow statements as a line item, accounts receivable, and a few other financial items. This information is used in annual reports in public companies to plan for the future and plan out hypothetical scenarios based on the previous year and what the future may hold.
• Pro forma earnings. The pro forma earnings statement helps with determining the sales projections for the upcoming year. This could include financial assumptions based on releasing a new product, undergoing an acquisition, or an increase in the cost of sales and current assets.

How to Make a Profit & Loss Statement (P&L)?

A pro forma is a financial statement designed to show the company’s financial position if it were to undertake a particular course of action.

It can be used for many things, such as predicting cash flows, determining whether an investment will be profitable, or even determining how much money a company needs to borrow.

In addition, a P&L is a statement that summarizes the profit and loss of an organization over a given period. It can also be called an income statement or an operating statement.

Well, making a P&L statement is easy but complex! It's easy to state that you just have to minus your losses from your profit. But in reality, you must put a lot of thought into everything and get detailed reports. Only then you’ll be able to make the correct predictions.

What are the Components of a Pro Forma Income Statement?

Pro forma financial statements forecast an organization’s future financial performance. It is used to assess the organization’s financial risk.

A proforma income statement includes the following components:

• Revenue. Revenue is the gross collections your business makes.
• Cost of goods sold. This is the total investment or cost of goods you sell to generate revenue. COGS is sometimes a significant cost or investment.
• Operating expenses. Running a business costs money. And operation expenses include paying rent, buying or leasing equipment, advertising, payroll costs, etc.
• Interest expense. It is a nonoperating expense, as mentioned above. When you take loans to establish your business, you have to repay that with interest.
• Income taxes. Income tax is another significant component to consider. Generally, for a good business, 30% of revenue goes into income tax. Therefore, you don’t want to ignore it while making a pro forma or P&L statement.
• Net Income. The revenue after taxes, deductions, wages, and all other charges is called net income. Net income is a business or company’s absolute profit after subtracting or paying off all other costs.

A pro forma income statement is a financial statement that reflects the financial forecast for a particular time. This type of income statement can be used to determine if the company will be profitable or not and drive business decisions.

Final Thoughts

An income statement summarizes all the revenues and expenses that have occurred for a time period. For example, an income statement for a company’s fiscal year will show the total revenue and expenses for that year.

Creating a pro forma income statement is crucial because it provides insight into how much money the company has made or lost during a specific time frame and is one of many key financial reports. The bottom line is creating your own pro forma income statement is a useful tool in the financial accounting of your company.

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