The term "pro forma" comes from latin. Pro means in advance of, preceding, or in support of. Forma means form or format. The term pro forma has been attributed to financial documents used to illustrate hypothetical or future financial transactions or future financial performance.
Pro forma financial documents are used in a variety of situations to document expected future financial performance or future financial transactions. Pro forma financial documents follow the format of conventional financial documents, but may use assumptions and variables that would not be recognized by formal accounting standards. The format may also be adapted to conventions based on the purpose of the pro forma document.
Examples of pro forma financial documents include pro forma invoices, pro forma cash flow statements, or other financial documents intended to portray or forecast financial performance.
In real estate, the importance of pro forma financial documents arises in situations where financial information and projections are necessary to estimate the future earnings potential of investment real estate.
The pro forma cash flow statement is an example of a pro forma document used to estimate the value of an investment property. Based on current performance and future assumptions, the pro forma cash flow statement projects important numbers such as effective gross income and net operation income (NOI).
By applying a cap rate to NOI, or a Gross Rent Multiplier to gross rent, market values are estimated for investment real estate. The pro forma method is important because it provides a benchmark for estimating future financial performance and estimating current market value.