What are pro forma earnings?

Pro forma earnings are based on an alternative measure of performance that typically excludes various costs at the discretion of the reporting entity, allegedly to compensate for difficiencies in Generally Accepted Accounting Principles (GAAP).

Because GAAP includes various non-cash charges and credits, as well as nonrecurring 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.

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.

The Securities and Exchange Commission dealt with the issue of pro forma earnings reporting in its Regulation G. Click here to access an article discussing Regulation G.

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