Pro forma earnings definition
/What are Pro Forma Earnings?
Pro forma earnings are based on an alternative measure of performance that excludes various costs at the discretion of the reporting entity. This is allegedly done to compensate for deficiencies in generally accepted accounting principles (GAAP). Businesses that are trying to impress investors with their earnings are the most likely parties to report pro forma earnings.
Advantages of Pro Forma Earnings
There are some distinct advantages associated with the reporting of pro forma earnings, which are as follows:
Focuses on core operations. Pro forma earnings strip out unusual or non-recurring items, such as restructuring costs, legal settlements, or one-time write-offs. This helps stakeholders focus on the company's performance from its regular business activities.
Improved comparability. By eliminating items that may vary significantly across periods, pro forma earnings allow for better year-over-year or quarter-over-quarter comparisons. This is particularly helpful for investors and analysts looking to assess trends.
Useful for forecasting. Pro forma earnings provide a baseline of consistent operational results, making it easier for analysts and management to project future performance without the noise of one-off events.
Highlights underlying value. For companies in growth or transition phases, pro forma earnings can demonstrate the potential value of their core operations, even when GAAP (Generally Accepted Accounting Principles) earnings appear distorted by temporary factors.
Customized form of presentation. Companies can tailor pro forma earnings to highlight specific operational achievements or areas of strength, especially during mergers, acquisitions, or restructuring processes.
While pro forma earnings have these advantages, they should be used alongside GAAP earnings to get a full picture of financial health. Over-reliance or manipulation of pro forma metrics can mislead stakeholders, which underscores the importance of transparency in how adjustments are calculated.
Disadvantages of Pro Forma Earnings
Pro forma earnings tend to exclude supposedly one-time expense events, and so nearly always reveal earnings that are better than those reported under a more strict interpretation of GAAP. However, one-time events are usually events that are recurring, just not very frequently, and so should be included in the calculation of earnings. In short, the users of a company’s financial statements are likely to be misled by reported pro forma earnings.
Regulation G
The Securities and Exchange Commission dealt with the issue of pro forma earnings reporting in its Regulation G. This regulation mandates that a publicly-held business cannot publicize a non-GAAP financial measure that contains an untrue statement of a material fact or which omits to state a material fact.
Related AccountingTools Courses
Public Company Accounting and Finance
The Interpretation of Financial Statements
Who Issues Pro Forma Earnings?
There is a tendency for pro forma earnings to be reported more frequently by those companies that are most interested in convincing investors to bid up the price of their stock. Consequently, investors should be careful about using this information in their analyses of companies. Privately-held entities have little reason to produce pro forma earnings information, since all shares are closely held.