This is “The Bigger Picture”, section 5.4 from the book Finance for Managers (v. 0.1).
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Pro forma statements are used to make many business decisions. Should we launch a new product line or open a new factory? Should we add another sales person or a worker in the plant? Pro formas use our best judgements to construct likely scenarios about the future. Accurately and appropriately used and constructed they can be helpful tools to improve our business.
When analyzing pro forma statements, it is important to understand how they were constructed, what the assumptions were and how to read them. Cash flows can be manipulated as well as assumptions. Economic and political conditions can change quickly which can strongly influence business outcomes. As with most predictions—take them with a grain of salt. No one can predict the future with 100% accuracy.
Managers within a company may have different objectives. Someone in sales may want to have a low sales projection so they are guaranteed to ‘hit their number’ and earn their bonus. A retiring manager may want to maximize their current year compensation or the company’s share price to maximize their retirement benefit. When constructing pro forma statements managers may also have different opinions on the likelihood of the outcome of each scenario. While pro forma statements are projections, many business decisions are based upon them. Correct calculation and analysis is important.