If you are a prospective business person, the income statement will be the key document advising you whether a business is earning or losing money. This is of paramount importance, If you're trying to raise money for a startup, the investor or venture group will expect you to prepare a projected income statement, often called a pro forma income statement or pro forma P&L (profit and loss). An entrepreneur should seek the assistance of a CPA to help with the preparation of such a document if he's unfamiliar with the process. He may also prepare one himself using Microsoft Excel or other software products that are available.
Importance of a Pro Forma P&L or Pro Forma Income Statement
An income statement measures profit or loss for a stated period of time: year, quarter, month, etc. It is the singular document used to measure the performance of a company. For startups, a lender or equity source, such as a venture capitalist, will expect to see a relatively formal projected or pro forma income statement as an essential part of the business plan. Microsoft Excel and the internet can provide some examples, but a prospective business person will need to fully understand the importance of the P&L and why investors expect to see one.
The pro forma income statement represents a company's projected performance, but does not include capital or cash contributed by stock holders, grants or any other balance sheet items. A balance sheet represents a snap shot in time of the firm's assets, liabilities and the stock holders' equity or "stake" in the firm. The pro forma income statement provides the entrepreneur's projection of his business operations for a specific projected period of time. Typically, a pro forma P&L for a startup would be projected for the first 24 or 36 months of expected operations. Along with the pro forma cash flow, the income statement will provide a good picture of a business' projected performance in its initial months of operation.
Preparing a Pro Forma Profit and Loss
The first element of an income statement is the sales portion. Typically, the company may have offered discounts to customers which would be subtracted from the total sales number:
That would be stated as: Sales $100,000
Less Discounts $10,000
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Net Sales $90,000
The next line will be Cost of Goods Sold which includes all of the materials and labor for a product or products, a single line item or several may be used to represent cost of goods sold:
Less: Cost of Goods Sold $70,000
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Gross Profit $20,000
Normally, the next major element that is subtracted from the gross profit will be operational expenses. These expenses are what the business must spend to produce and ship a product. It is formatted as follows:
Less: Operational Expenses
Salaries $4,000
Sales Commissions 2,000
Production Supplies 2,500
Packaging 1,500
Freight & Shipping 1,000
Utilities 1,800
Office Expenses 150
Misc. Expenses 50
Depreciation 2,000
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Total Operational Expenses: $15,000
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Operating Profit: $5,000
Note that depreciation, while not a cash, out of pocket expense, is based upon the useful life of plant/equipment. Typically, straight line depreciation can be used which states that the useful life of an asset is n years. Therefore, the yearly expense is 1/nth multiplied by the original cost of the asset.
All other expenses that might be ancillary and miscellaneous are added and subtracted as non operational expenses from the operating profit of $5,000 resulting in the net profit. Normally, federal income tax on net profit is paid on the basis of net profit. For simplicity, it is not calculated in this example.
Less: Non Operational Expenses
Professional Fees $ 750
Employee Health Insurance 1,250
State & Local Taxes, etc. 400
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Total Non Operational Expenses $3,600
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Net Profit $1,400
Depending upon the type of business model or product or services sold will determine, obviously the types of income and expense accounts that will define the income state format. The above format will be similar to most other businesses and serves as a typical model for how a pro form income statement might be structured. It is important to stress that once a pro forma income statement has been developed, it should be taken to a CPA to make certain that the it is complete and in the proper format.
In a situation where a business person is attempting to raise capital for a start up, a pro forma cash flow statement will also be of obvious interest to a funding source. Other financial documents will probably be required during the funding process, such as a pro forma statement or pro forma balance sheet.
Nick Schklair - Nick Schklair, author, writer and business consultant has published a work on business startups in today's economy.
