What is your balance sheet going to look like next year? The year after? What about three years from now? Do you care? Many times the answers to these questions are: not sure, no idea, don’t know and yes I care but I don’t have the information to properly answer these questions. It’s very typical for a small or medium sized business to not know what their financial statements are projected to look like over the coming year much less the next three years. Many times they will have a budget (that is usually inconsistent with their historical performance) but haven’t done the work to take the budget one step further and have it flow into an actual set of pro forma financial statements.
What are pro forma financial statements and why do they matter?
As much as I enjoy working with small businesses, one of the points of friction when discussing business loans (or commercial mortgages in some cases) is the matter of pro forma financial statements. As I have written in the past, most businesses run their business plan from their profit and loss statement. A profit and loss statement shows revenue less expenses to equal what’s left over in the form of net income. Many small businesses don’t bother looking at their balance sheet which shows them the other side of the ledger – what their business owns versus what their business owes. A prudent business owner will look at their profit and loss in addition to their balance sheet on a regular basis to measure the performance of the business and some even go further to project what they think their balance sheet and income statement will look like over the next few years. These are referred to as “pro forma” financial statements.