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
Because GAAP includes various non-cash charges and credits, as well as non-recurring gains and losses, the argument in favor of pro forma earnings states that GAAP does not provide investors with a true picture of an entity's performance. Thus, the intent of pro forma earnings reporting is to reveal an entity's "normalized" earnings, which typically do not include such items as charges for layoffs, inventory obsolescence, or asset impairments.
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.