Steps to Prepare a Pro Forma Financial Statements

Since we are making a projection about the future, there is no single correct answer. You need to
make what you feel are reasonable assumptions and proceed. We have to develop based on
projection from past performance, and our knowledge of the situation. You can and should
experiment and change the assumptions, per step 6 below, in order to sensitize your results to the
assumptions and estimates.
Steps for preparing a pro forma income statement and balance sheet include:
1. Set up a spreadsheet with the income statement and balance sheet data for past three years. .
I think it is useful to setup a new combined Workbook type of linked spreadsheets, with the
income statements as Sheet 1, the Annual balance sheets as Sheet 2, and then ratios, etc, in
Sheet 3. Note that the original balance sheet information is yearly data.
2. Compute the income statement and balance sheet numbers as a percent of total revenue.
3. Forecast sales for 1999. You are given an expected growth rate in sales, and this is easily
translated into a sales prediction for 1999. One important later activity will be to perform
sensitivity analysis around this figure. What will happen if sales actually decline, say %
percent? What will happen if sales should grow by 25 percent? These are sensitivity
analysis activities.
4. Project next year's (1999) income statement numbers as a function of prior period's
percentages, modified by your beliefs, trends, more recent information, etc. You should be
able to do with within the income statement spreadsheet.
5. Project next year's balance sheet numbers as follows.
A. Determine pro forma balance sheet numbers for those items likely to vary directly with
sales.
B. Close your estimated income from the projected income statement to retained earnings.
C. Estimate the effect of stock repurchase amounts on treasury stock, given information and
projections made by management. This will be a rough estimate.
D. Insert reasonable but admittedly rough estimates for remaining balance sheet items. For
example, you are given some guidelines on expected changes in PP&E.
E. The "plug" account is likely to be cash, or if cash dips below some predetermined
minimum balance, then the plug becomes "borrowings needed." Essentially you are
solving for financing needs or excess cash.
6. Conduct sensitivity analysis as useful by changing key assumptions.