Firms construct pro forma financial statements by studying past relationships between key accounts on the income statement and making judgments about whether those relationships will continue in the near future. Many of the financial ratios introduced earlier in this text play an important role in the creation of pro forma financial statements.

Managers require two main inputs to prepare pro forma statements:

$($

$1$

$)$

$$financial statements for at least the preceding year and

$($

$2$

$)$

$$the sales forecast for the coming year. Given those inputs, managers make a variety of assumptions based on historical financial relationships to construct projected income statements.

A simple method for developing a pro forma income statement is the percent

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of

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sales method. It forecasts sales and then expresses the various income statement items as percentages of projected sales. The percentages used are likely to be the percentages of sales for those items in the previous year.

To Do

In this assignment, you will create a pro forma income statement involving your group

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s fictitious firm. A pro forma income statement can be developed by calculating past percentage relationships between certain cost and expense items and the firm's sales and then applying these percentages to forecasts. Pro forma statements are commonly used to forecast and analyze the firm's profitability and overall financial performance so that managers can make adjustments to operations to achieve short

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term financial goals.

Despite their weaknesses, pro forma financial statements remain useful to managers. What are some of these weaknesses? What are some practical reasons a financial managers would evaluate pro forma statements?