The Pro and Cons of Pro Forma Accounting

Pro forma is a Latin term meaning “for form’s sake.” It refers to practices that are carried out “for formality’s sake.” These activities are done for superficial decorum. Pro forma accounting would then mean accounting activities that are done for formality’s sake. Pro forma, in accounting, is a financial statement based on future activities of a business without the lesser transactions incurred by the business. These lesser transactions are called non-recurring costs, or costs that a certain business would less likely encounter again.

Pros of Pro Forma Accounting

Actual outcomes may be formulated.Pro forma accounting statements are used to determine if a business will be profitable. It serves as a financial guide for future businesses. It can determine the risks that may be encountered in starting a business, thus prompting starting business owners to come up with solutions to possible business problems.

It can help determine a company’s future financial status.Pro forma financial statements calculate a business’ forthcoming financial gains and expenses. These statements can usually determine the cash flow of a business for a course of 10 years. They can also help businesses prepare for future financial changes. Pro forma accounting statements are utilized by companies who plan to merge with other companies, or sell off or buy assets. For merging companies, pro forma statements determine what the companies stand to gain from the merger. They can also determine which company can provide the highest gain for another. As for the sale and/or acquisition of assets, pro forma statements forecast what becomes of a property should they choose to buy/sell it or proceed otherwise.

It serves as a guide in credit decisions. Most lender companies use pro forma accounting statements as determinants of future outcomes should they choose to approve or deny loans. These statements are invaluable in banking and credit since they predict possible financial consequences.

Cons of Pro Forma Accounting

Pro forma accounting statements are mostly guesses.Pro forma statements are mostly based on assumed numbers. Because these are assumptions, full reliance on pro forma statements is not recommended.

It does not follow the Generally Accepted Accounting Principles (GAAP). The GAAP is a set of accepted guidelines in performing financial accounting activities. GAAP is composed of principles of regularity, consistency, sincerity, permanence of methods, non-compensation, prudence, continuity, periodicity, and full disclosure/materiality. Pro forma accounting is not carefully analyzed. It can be manipulated to give out a desirable report.

Pro forma accounting statements don’t have a well-defined basis. Because pro forma statements are mostly guesses, the background of their predictions is shaky. They can be deceptive. For example, a company may give a pro forma report saying that they have earned 42 cents per share when in fact; under the GAAP, the company actually lost 59 cents per share. In short, pro forma statements and numbers are not the exact reflections of a company’s financial standing.