Question

In class discussion about Financing Business Ventures, articulated the development of and need for assumptions in pro forma statements. What role do revenue and expense assumptions play in the development of pro forma statements? Which assumptions do you feel are the most important to developing your business's pro forma statements? support your response?

Answer 1

A)To create a pro forma income statement following assumptions are required to be considered.

1. Step 1: Calculate the estimated revenue projections for your business (this is called pro forma forecasting). Use realistic market assumptions and not just numbers that make you or your investors feel optimistic. Do your research and speak with experts and accountants to determine what a normal annual revenue stream is, as well as asset accumulation assumptions. Your estimates should be conservative.
2. Step 2: Estimate your total liabilities and costs. Your liabilities include loans and lines of credit. Your costs will include items such as your lease expense, utilities, employee pay, insurance, licenses, permits, materials, taxes, etc. Put in a great deal of thought into each expense and keep your estimates realistic.
3. Step 3: To create the first part of your pro forma, you’ll use the revenue projections from Step 1 and the total costs found in Step 2. This portion of the pro forma statement will project your future net income (NI).
4. Step 4: Estimate the cash flows. This portion of the pro forma statement will identify the net effect on cash if the proposed business change is implemented. Cash flow differs from net income because, under accrual accounting, certain revenues and expenses are recognized prior to or after cash changes hands.

B) Most Important assumptions in Pro forma statements are -

• Income and expense assumptions
• Inventory and Accounts receivable in the balance sheet