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How Pro Formas Affect Your Cannabis Business

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February 12, 2019

Anyone who owns a cannabis business has probably heard of the term “pro forma.”  

However, not all business owners understand how powerful a tool pro formas can be to demonstrate how much money the business needs to start up and operate until it is able to generate profits.

Usually, companies that are raising capital or are looking to be acquired by another business entity or individual seek professional public accountants to put together pro formas in order to value its business. 

What is a Pro Forma?

A pro forma is a set of financial documents that demonstrate how funds are used or are going to be used, and how the money raised will impact a company’s financials.

That said, individuals or firms who prepare such documents make supported assumptions in developing projections. They think carefully about ensuring the financial numbers are reasonable and provide insight into significant gains that a prospective buyer or investor can use to decide to purchase or fund the business.

Pro Forma Components

There are several key components to pro formas. They are:

  1. Income Statement: This is also commonly referred to as a “Profit and Loss Statement” or P&L. Income Statements report income during a particular reporting period. It focuses on a business’ revenue, gains, expenses, and losses.

  2. Balance Sheet: This is a financial statement that reports a company’s assets, liabilities, and shareholder’s equity during a specified reporting period. Balance Sheets also provide basis for computing return rates and can assist in providing key insight into assessing a company’s capital structure.

  3. Statement of Cash Flows: This is a financial report that exhibits the net amount of cash that goes into or passes out of a company. Generating positive cash flow demonstrates a business’ ability to create value to shareholders.

  4. Sources and Uses of Funds: This financial report is especially important to investors. Sources and uses of funds exhibit where all the funds a business is able to raise comes from, and how these funds will be used in the business. The total sources of funds must always match the total uses of funds.

Pro Forma Features

The most crucial features of each component that potential buyers and investors look at are: 

  1. Gross Margins: Gross Margins are the total sales revenue of a business, minus its cost of goods (COGS) sold, which is then divided by the total sales revenue. Gross Margins are expressed as a percentage. The higher the percentage of a company’s gross margins, the more the company is making on each good sold.

  2. EBITDA: Earnings Before Interest, Tax, Depreciation, and Amortization (EBIDTA) is a measure of a company’s performance, which is done by taking the company’s non-cash expenses of depreciation and amortization and adding it onto a company’s operating income.

  3. Growth Rates: Growth Rates are used to show assess a company’s growth and make future assumptions of the company’s performance in terms of revenue and production. Growth rates can be used to assess a company’s profitability, and can also be applied to other relevant metrics to make other determinations and assumptions that affect a company’s performance.

  4. Payback Periods: Payback Periods give insight into how long it will take an investor to recoup his or her investment. The shorter the payback period, the more attractive the investment is.

  5. Returns on Investments: Returns on Investments or ROIs measures the gains or losses on an investment based on the amount of money that was invested. Typically, this performance measure is used to evaluate the efficiency of an investment or compare the efficiency against several other investments.

These pro forma components and features are important to business owners, investors, and potential buyers for several reasons.

First, this information can be used to leverage investment pitches and strengthen business plans that are presented to potential investors.

Second, it can be used to develop an operating budget to ensure that a business does not run out of money before it becomes profitable.

And third, it can be used to value a business or a company that could be sold or acquired.

How to Determine How Much Money Your Cannabis Company Should Raise

Pro formas are can provide significant insight into how much capital or funding a company needs to raise. The pro forma would provide a snapshot into Capital Expenditures and Working Cash Flow that outlines a company’s expenses and the required capital to cover those expenses. 

When pitching to potential investors, a company’s pro forma will be able to demonstrate how investor’s money will be used. It will also be able to indicate how much cash the business/company will be able to generate with appropriate funding.

Check out this blog post on calculating startup costs for your cannabis business.

What Should You Take Into Consideration When Raising Capital?

A company or a business raising capital should take four things into consideration:

  1. Clearly define your business plan. This includes having a strong financial report (Pro Forma) that demonstrates how much your company will need to start up, how the funds will be used, how long it will take for the company to become profitable, and its growth rate to show how much value an investor is looking at if he or she decides to invest in your company/business.

  2. Clearly define in the business plan how the money/funds will used. Being able to clearly demonstrate where sources of funds are coming from, and where these funds will be used will provide a better sense of security to any investor.

  3. Make sure that you raise enough money, including enough for a contingency fund. The worst thing that can happen is having a business run out of funding before it becomes profitable.

  4. Make sure you know your numbers and that they work. Ensuring that the underlying assumptions that are used in your company’s financial reports & models are accurate and well-supported can provide more reliability and industry expertise that investors look at when deciding to invest.

Are you in the process of putting together a business plan for potential investors?

Or are you ready to sell your business and need to get it valued? We can help you create pro formas that assist companies and businesses fundraise and get valued. 

Click the "Get Started" button below to contact a team member today.

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Filed Under: Finance