by Al Davis and Nicola Roark
Do these really matter or could you take your great idea, score some investment money and get your product to market more quickly without pro formas?
This question puzzles a lot of startups so let’s answer it. While there’s no wrong answer, each path has its own likelihood of success:
No pro forma financial statements = low probability of success
The reason this path has low probability of success is not because you don’t have a great idea! Your idea is probably fantastic but it’s even better when you can back it up with financial assumptions that make sense.
The reality is that investors place their bets on startups less than 3% of the time.
And when they bet on a startup, they demand pro forma financial statements and at least some kind of detailed plan for the business.
The other 97% of their money goes to businesses that have already been through rounds of funding and have demonstrated that there is a market willing to buy their product.
Pro forma financial statements = high probability of success
Investors take their risks with those that have a reasonable chance at being successful and returning their investment, plus some, to them. Investors want to know when to expect a return on their money. Pro forma financial statements tell them that.
Let’s take a quick look at the pro forma financial statements that all investors expect from a startup. Understanding the value of each adds tremendous power to running your business, growing your business, and to the proposition you make to investors.
Your pro forma income statement (also called profit and loss statement, or P&L statement) is the tool used by businesspeople and investors to determine if a company is profitable (or not) over a period of time.
It shows what the revenues, cost of goods sold, expenses, and profits of a company would be, based on a set of given assumptions. Your income statement answers seven questions for you and your potential investors. To learn more about these questions and their answers, read Seven Things an Income Statement Tells You.
Using your income statement is the best way to find out how efficient your company is in generating that profit from the sales. These are imperatives for launching and running a viable business.
Your pro forma cash flow statement shows all cash that you expect will come into the company and all cash that you expect will go out of the company during a period of time based on your stated assumptions.
Many new entrepreneurs confuse cash with profit. Your company could be profitable (as reported on your pro forma income statement) and you could still run out of cash.
The cash flow statement answers four questions for you and your potential investors. To learn more about these questions and their answers, read Four Things a Cash Flow Statement Tells You.
Your pro forma balance sheet shows all the things your company would own (its assets), all the things it would owe (its liabilities), and their difference (shareholders’ equity), based on your assumptions.
The balance sheet answers four questions for you and your potential investors. To learn more about these questions and their answers, read Four Things a Balance Sheet Tells You.
Understanding the value of your pro forma financial statements is not only a benefit to you and your business, it’s an expectation from investors. They are the compass on your business journey and without them you’ll quickly start drifting.
Using your pro forma financial statements to chart your course, demonstrate your business acumen, and recommend course changes is the most reliable compass you, and your investors, can have.
Al Davis is a Serial Entrepreneur, Angel Investor and Author of six books. He is CEO of Offtoa, Inc., his fifth startup.
Nicola Roark is a Marketing Consultant and Strategist working with entrepreneurs and startups. Her business allows her to do two things she loves; collaborate with businesses who have a dream and develop the strategy and content to take it to market. Visit her website: www.exhilarationmarketing.com or email her: firstname.lastname@example.org for more details.