What is pro-forma modeling?

Finance professionals use pro-forma modeling to leverage current and historical financial statements in an effort to predict future business results. The term pro forma is Latin for “as a matter of form.” Read more on the subject here.

Screenshot of a Pro-forma Balance Sheet
Interbank Lending from 1975 to 2015

Pro-Forma balance sheet

When is pro-forma modeling used?

Pro-forma modeling is often used in advance of a proposed transaction. This could be the acquisition of a smaller competitor, the utilization of debt, or a proposed increased equity stake in the company. For example, lets say Western Digital (Ticker symbol WDC) desires to raise capital to purchase a competitor, SanDisk. Western Digital is a primarily a producer of spinning hard drive devices, while SanDisk is a leading manufacturer of NAND flash, which is a fast type of memory used in electronic products such as iPhones and tablet computers. By acquiring SanDisk, Western Digital believes they can better diversify their product offerings. However, the enterprise value of each company is roughly equivalent. Is it wise to diversify or will the diversification bankrupt the company?

A financial analyst will begin his analysis by examining the historical financials. In the United States, these are found On the Securities and Exchange Commission webiste. Another reliable source is Last10k.com, which will conveniently provide the financials in an Excel format. (Note that professionals will often use an Excel plugin such as CapIQ to obtain these numbers.) With these financials, he will then create a Three Statement Model based on 1) the historical balance sheet, 2) the historical income statement, and 3) the historical statement of cash flows. The statement of cash flows is the most useful of the three to an investor, but it is built based on the balance sheet and income statement. Some other common models are listed below.

What Types of Financial Models Are There?

  1. Three Statement Model (see above)
  2. Discounted Cash Flow Model –> A method to value a company. This is often used in conjunction with the three statement model (enterprise value = firm’s future anticipated free cash flows)
  3. Leverage Buyout Model –> Used by buy-side firms to calculate ROI and other measures of an investment’s success or failure.
  4. Option Pricing Model –> Used by equity analysts and companies to value stock options.
  5. Merger Model –> Used by sell-side firms to analyze the combination of two companies.