All businesses should have a business plan; first, as a road map for managing business activities, but also as part of a loan package to present to lenders and stockholders. As part of your planning and projections for the future, your business plan should contain a “pro forma” statement. “Pro forma” means “to provide in advance” or “serve as a model”. A pro forma projection is just that-a prediction of what may happen in the future. You and your lenders need to know:
- When you expect your business to break even; when or if you, as the business owner, are planning on drawing a salary; or if you will have enough profit to pay your debts and your investors.
- How to plan for sufficient capitalization for your business in the short- and long-term. Undercapitalization is one of the major reasons for business failure.
Pro forma statements begin with predictions of expected revenue. This is not the same as revenue “goals”. All businesses have healthy revenue goals they would love to meet, but when preparing a pro forma sheet, realism must rule the roost. Based on your company’s sales history, or if your business is new, market research of businesses similar to yours, you calculate what you can expect to bring in as revenue in the time period of the report. You determine both what you typical sale is and also how many customers or clients you will have. It is a good rule of thumb, especially if you are a new business basing your projection on market data, to reduce your pro forma estimates by about 20%. You can always adjust your numbers later; hopefully in an upward direction.
After projecting your revenue, it is time to predict your expenses. Direct expenses, labor costs, variable and indirect or fixed costs must be considered. Your pro forma is used to predict growth; so while you are predicting growth in revenue, make sure to also figure any expected growth in expenses.
A pro forma statement is a more detailed financial report that can be produced by your accountant on a monthly or quarterly basis. Using the data contained in your business accounting software program, the variables can be the basis for projections as far into the future as you and your lenders and investors would like. If you use online accounting software, it will be much easier for you and your accountant to work concurrently to assure that you are being proactive in managing the financial affairs of your business. You will be much better positioned to take advantage of future opportunities and avoid future problems.