Pro Forma Statements vs. GAAP Statements: An Overview
The generally accepted accounting principles (GAAP) require American-based companies to adhere to uniform reporting standards that govern accounting in the U.S. However, companies increasingly supplement their GAAP financial statements with pro forma financial statements. Their management's rationale is that that GAAP statements do not provide a true picture of the company's operations; by using pro format financials to adjust GAAP statements, they provide investors with a better understanding of the company's financial condition, results, and prospects.
- In the U.S., Companies increasingly supplement their generally accepted accounting principles (GAAP) financial reporting with pro forma financial statements.
- Pro forma statements include adjustments made to GAAP statements to provide a "truer" picture of the company's finances.
- Such adjustments include removing non-recurring charges, such as restructuring and litigation costs.
- Pro forma statements can be more accurate than GAAP statements, but they can also be abused, as certain charges can be excluded even though they really belong on the statement—or they're deemed "nonrecurring," but do repeat year after year.
In the U.S., the generally accepted accounting principles (GAAP) refer to a common set of accounting rules, standards, and procedures issued by the Financial Accounting Standards Board (FASB). Public companies in the U.S. must follow GAAP when their accountants compile their financial statements to file with the U.S. Securities and Exchange Commission (SEC) and to release to their investors. Although not required by the SEC, many private firms also follow GAAP.
GAAP's goal is to ensure a company's financial statements are complete, consistent, and comparable, no matter what their industry or business sector.
Pro Forma Statements
Adjustments made to GAAP statements to create pro forma statements include litigation costs, restructuring charges, and other nonrecurring items. A company that wishes to inform its investors about these things, and their impact on the bottom line, prepares a pro forma income statement to adjust GAAP earnings for any litigation gains or losses. Unlike GAAP's emphasis on historical transactions, a company can use pro forma statements to show projections of its earnings, too.
Occasionally, pro forma financial statements refer to a forecasting method under which financial numbers from the previous two or three years are used. The company's management prepares pro forma financial statements for mergers and acquisitions proposals as well as loan applications.
Pro forma is a Latin term that means “for the sake of form” or “as a matter of form,” but in modern parlance, it has come to mean a standard document, form, or financial statement.
Real-World Pro Forma Example
For example, in its fiscal year 2021 annual report, Best Buy (BBY) noted a $21 million price-fixing litigation settlement, received in relation to products purchased and sold in prior fiscal years. Because this is a nonrecurring item, the company subtracted this gain from its operating revenues in its pro forma income statement, to report a "non-GAAP operating income" of $2.7 billion.
Other nonrecurring items that companies tend to use in adjusting GAAP earnings for pro forma statements are restructuring charges. In 2021, Best Buy reported $23 million of charges associated with restructuring its business—specifically, inventory markdowns "associated with the decision to exit operations in Mexico." The company did not expect to incur such charges in the future. On its pro forma income statement, Best Buy added back this restructuring charge to its net income.
Best Buy characteristically includes pro format statements in its annual reports and other public filings. "We believe that non-GAAP financial measures, when reviewed in conjunction with GAAP financial measures, can provide more information to assist investors in evaluating current period performance and in assessing future performance," the company says. " These non-GAAP financial measures should be considered in addition to, and not superior to or as a substitute for, GAAP financial measures."
Using pro forma results to grossly misconstrue GAAP-based results and mislead investors is deemed by the U.S. Securities and Exchange Commission (SEC) to be fraudulent and punishable by law.
The pro forma financial statement is often a more accurate representation of the company's financial results and position. However, a company might abuse pro forma statements by excluding certain charges that really do belong in the financial statements. One prominent example is stock-based compensation.
Stock options may not represent an immediate cash charge to the company, so it might exclude expenses associated with stock options on the pro forma statement. However, stock options are traded, they have value and affect the company's earnings through dilution. Ignoring stock-based compensation can mislead investors, especially if most of the employees' compensation is in the form of stock options.
A company's claims that certain charges are nonrecurring should also be taken with care. Certain companies incur litigation charges very frequently due to the inherent nature of the business, such as medical practices. If these charges recur every year and the company excludes them on the pro forma statements, the company's management may be misleading its investors.
Are Pro Forma Financial Statements GAAP?
No, they're the opposite. Pro forma financial statements are defined as those that do not follow generally accepted accounting principles—and that's the point of them: to include or exclude items that GAAP wouldn't allow. In fact, in annual reports or other filings, pro forma statements are often titled "Non-GAAP Financial Statements or Measures."
Why Do Companies Report Both GAAP and Non-GAAP or Pro Forma Earnings?
Companies report both GAAP and non-GAAP (pro forma) earnings when the two reveal different things. While GAAP figures indicate how much money your company made overall during a quarter or year, pro forma earnings tell you how much your company made from its usual, or ordinary business activities in that same period—they strip out extraordinary or one-time events, good or bad. Investors, analysts, and creditors often like to look at both sets of numbers.
What Is the Purpose of a Pro Forma?
A pro forma financial statement allows a company to exclude special nonrecurring gains or losses, like a legal settlement, merger-related expenses, or spinning off a division. Pro forma statements also allow companies to project future earnings or anticipated income, instead of just reporting results from the past.