How to Do a Pro Forma Balance Sheet

Building a pro forma balance sheet allows you to project your company's future financial position, turning your business plan into quantifiable data. It’s an essential tool for assessing the financial impact of your goals, whether you're seeking funding, planning a major acquisition, or simply stress-testing your annual budget. This article will walk you through, step-by-step, how to construct a reliable pro forma balance sheet to guide your business decisions.

What Exactly Is a Pro Forma Balance Sheet?

A pro forma balance sheet is a forward-looking financial statement that projects the values of a company's assets, liabilities, and owners' equity for a future period. Unlike a standard balance sheet, which reports on a company's financial position at the end of a historical period, a pro forma statement is a forecast built on a set of assumptions about what will happen in the future.

Think of it as a financial "what if" analysis. It helps you answer critical questions like:

• If we grow our sales by 20%, how will that affect our inventory levels and accounts receivable?
• How much additional financing will we need to support a planned expansion?
• Can we afford to buy new equipment without taking on too much debt?
• Will our business have enough cash to remain solvent if our revenue targets aren't met?

You’ll use a pro forma balance sheet when presenting to banks for a loan, courting potential investors, and for internal strategic planning. It bridges the gap between your operational plans and their financial consequences, ensuring your entire business strategy holds together.

Gathering Your Data and Assumptions

The accuracy of your pro forma balance sheet rests entirely on the quality of your inputs and the reasonableness of your assumptions. Before you begin building the statement, you need to collect several key pieces of information.

• Historical Balance Sheet: Your starting point is always your most recent, finalized balance sheet. The ending balances from this statement will become the beginning balances for your pro forma period. You can easily pull this from accounting software like QuickBooks Online or Xero.
• Pro Forma Income Statement: You cannot create a pro forma balance sheet in isolation. You first need to prepare a pro forma income statement for the same period. The net income figure from this statement is a critical input, as it directly affects your retained earnings in the equity section of the balance sheet.
• Strategic Plans and Assumptions: This is the narrative behind the numbers. Document your assumptions about key business drivers. This includes your sales growth forecast, plans for major capital expenditures (like buying new machinery), anticipated financing activities (new loans or equity infusions), dividend policies, and changes in operational efficiency (like quicker inventory turnover).

How to Create a Pro Forma Balance Sheet, Step-by-Step

Once you've gathered your information, you can begin constructing the pro forma balance sheet. The goal is to project the ending balance for each account and ensure the fundamental accounting equation—Assets = Liabilities + Equity—remains in balance.

Step 1: Start with Your Prior Period's Balance Sheet

Use your most recent historical balance sheet as a template. The ending balances for each account (Cash, Accounts Receivable, PP&E, Accounts Payable, etc.) become the starting point for your projections.

Step 2: Project Your Future Assets

Now, forecast the ending balances for your asset accounts, one by one. It's often helpful to separate them into current and non-current assets.

Current Assets:

• Accounts Receivable (AR): An increase in sales usually means an increase in AR. A standard method is to forecast AR as a percentage of your projected annual sales. For more precision, calculate your company's Days Sales Outstanding (DSO) from historical data and apply it to your sales forecast. For example, if your DSO is 45 days, your projected AR would be (45 / 365) * Projected Annual Sales.
• Inventory: Like AR, inventory levels are tied to sales activity—specifically, the cost of generating those sales. You can project inventory as a percentage of your projected Cost of Goods Sold (COGS). A good metric here is Days Inventory Outstanding (DIO). If your DIO is 60 days, your ending inventory is (60 / 365) * Projected Annual COGS.
• Cash: This is often the last item calculated and serves as the "plug" figure to make the balance sheet balance. For now, leave it blank or as a placeholder. We’ll come back to this in Step 6.

Non-Current Assets:

• Property, Plant, & Equipment (PP&E): This calculation has three parts: Beginning PP&E + Capital Expenditures – Depreciation.
  • Beginning PP&E: This value comes directly from your historical balance sheet.
  • Capital Expenditures (CapEx): Add any planned purchases of new equipment, buildings, or other long-term assets. This should come from your budget or strategic plan.
  • Depreciation: This expense comes from your pro forma income statement. Subtracting it here reflects the decrease in the book value of your assets.

Step 3: Project Your Future Liabilities

Next, forecast your liability accounts by analyzing how they’ll change based on your operational and financing plans.

Current Liabilities:

• Accounts Payable (AP): This is closely tied to your purchasing activity, which is driven by your COGS. You can calculate AP as a percentage of COGS. A common approach is to use your company's Days Payable Outstanding (DPO). For example, if your DPO is 30 days, your projected AP would be (30 / 365) * Projected Annual COGS.
• Short-Term Debt: Refer to your loan agreements or line of credit to see if any new debt is planned or if existing portions will be paid down.

Non-Current Liabilities:

• Long-Term Debt: Start with the beginning balance and subtract any principal payments scheduled during the period. Then add any new long-term debt you plan to take on, such as a loan for the CapEx you forecasted in the assets section.

Step 4: Project Your Shareholders' Equity

Equity is the crucial link between your pro forma income statement and your pro forma balance sheet.

• Common Stock / Paid-in Capital: This account only changes if you plan to issue new stock to raise capital. For most small and mid-sized businesses, this number remains the same period-over-period.
• Retained Earnings: This is the most dynamic part of the equity section. The formula is: Beginning Retained Earnings + Projected Net Income – Projected Dividends. You'll pull the Beginning Retained Earnings from your prior period’s balance sheet and the Projected Net Income directly from your pro forma income statement.

Step 5: Assemble and Sum Your Projections

At this stage, you have projected figures for almost every line item. Create a balance sheet with three sections: Assets, Liabilities, and Equity. Sum the totals for each section.

• Total Assets = Projected Current Assets (except cash) + Projected Non-Current Assets
• Total Liabilities and Equity = Projected Current Liabilities + Projected Non-Current Liabilities + Projected Shareholders' Equity

Step 6: Balance the Sheet with a "Plug" Figure

When you first sum your projections, Assets and Liabilities + Equity will almost certainly not be equal. The difference between these two totals needs to be "plugged" into an account to make the sheet balance. The account you use for the plug depends on your financing strategy.

• If Total Liabilities and Equity > Total Assets: This means your operations and financing activities are projected to generate more cash than you've accounted for. The difference is your projected ending Cash balance. This is the most common scenario for profitable, stable companies.
• If Total Assets > Total Liabilities and Equity: This indicates a funding shortfall. Your planned assets are greater than the resources you’ve forecast to pay for them. The plug here will typically be new financing, such as a Line of Credit or Short-Term Debt, showing how much you’ll need to borrow to make your plan work.

Once you’ve added the plug figure, your pro forma balance sheet should balance perfectly (Total Assets = Total Liabilities + Equity).

Best Practices and Common Mistakes

Creating a pro forma balance sheet is part art, part science. Your judgment is key. Here are a few tips to ensure your forecast is valuable:

1. Scrutinize Your Assumptions. This is the most important element. Unrealistic sales growth or optimistic expense assumptions will result in a misleading forecast. Be prepared to defend every assumption with data, industry benchmarks, or a clear strategic rationale.
2. Link Your Financial Statements. Do not build your pro forma balance sheet in a vacuum. It must be dynamically linked to your pro forma income statement and, ideally, a pro forma cash flow statement. The flow of Net Income into Retained Earnings is non-negotiable.
3. Build Different Scenarios. Your initial forecast should be your "base case." But what happens if sales come in 15% lower? Or if a key supplier raises prices? Build best-case, worst-case, and base-case scenarios to understand the full range of potential outcomes and prepare for them.

Final Thoughts

A pro forma balance sheet systemically translates your business assumptions into a forward financial picture. By following a structured process of projecting assets, liabilities, and equity based on your planned operations and tying it back to your pro forma income statement, you create a powerful tool for strategic decision-making and financial planning.

The forecasting process often unearths complex questions related to tax planning, especially around depreciation rules like Section 179 or bonus depreciation, or the tax implications of different financing structures. Instead of pausing your planning to manually sift through the IRC, you can build your models with greater speed and confidence. When those complex tax questions arise during your scenario modeling, Feather AI gives you instant, citation-backed answers, ensuring your financial assumptions are built on a defensible foundation from the start.