Question

Discuss the impact of the pro forma financial statements for predicting ability to meet future expansion goals

Answer 1

A pro forma financial statement is one based on certain assumptions and projections. For example, a corporation might want to see the effects of three distinct financing options. Therefore, it prepares projected balance sheets, income statements, and statements of cash flows. These projected financial statements are referred to as pro forma financial statements.

The impact of pro forma financial statement in predicting the ability of the business in determining the future expansion goals in which :- Businesses uses pro forma statements for decision-making in planning and control, in order to attain the ultimate goal of expansion.

Pro forma statements can be used as the basis of comparison and analysis to provide management, investment analysts, and credit officers with a feel for the particular nature of a business's financial structure under various conditions with the help of which the owners of the business can determine the businesses’ ability to expand.

As a vital part of the planning process, pro forma statements can help minimize the risks associated with a running business. They can also help convince lenders and investors to provide financing for expanding and diversifying.

Pro forma statements must be based upon objective and reliable information in order to create an accurate projection of a small business's profits and financial needs for its first year and beyond. After preparing initial pro forma statements and getting the business off the ground, the small business owner should update the projections monthly and annually in order to attain the ultimate goal of expansion.

Company uses pro forma statements in the process of business planning and control. Because pro forma statements are presented in a standardized, columnar format, management employs them to compare and contrast alternative business plans. By arranging the data for the operating and financial statements side-by-side, management analyzes the projected results of competing plans in order to decide which best serves the interests of the business. It helps in reviewing proposed decisions in marketing, production, research and development, etc., and assess their impact on profitability and liquidity.

Based on different sets of assumptions, these plans propose various scenarios of sales, production costs, profitability, and viability. Pro forma statements for each plan provide important information about future expectations, including sales and earnings forecasts, cash flows, balance sheets, proposed capitalization, and income statements.

During the course of the fiscal period, management evaluates its performance by comparing actual results to the expectations of the accepted plan using a similar pro forma format. Management's appraisal consists of testing and re-testing the assumptions upon which management based its plans. In this way pro forma statements are indispensable to the control process.