What Are Pro-Forma Earnings?
Pro-forma earnings most often refer to earnings that exclude certain costs that a company believes result in a distorted picture of its true profitability. Pro-forma earnings are not in compliance with standard GAAP methods and are usually higher than those that comply with GAAP. The term may also refer to projected earnings included as part of an initial public offering or business plan (in Latin pro forma means "for the sake of form").
Pro-Forma Earnings Explained
Pro-forma earnings in the first sense are sometimes reported by publicly traded companies that want to present a more positive picture of their financial condition to investors. Pro-forma earnings may be either higher or lower than GAAP earnings, but typically they are higher.
Pro-forma earnings may exclude items that don't normally occur as part of normal operations, such as restructuring costs, asset impairments, and obsolete inventories. By excluding these items, the company hopes to present a clearer picture of its normal profitability.
However, some companies have been known to abuse this practice by repeatedly excluding items that should normally be included. Investors should, therefore, exercise caution when using pro-forma earnings figures in their fundamental analysis. Unlike GAAP earnings, pro-forma earnings do not comply with standardized rules or regulations. As a result, earnings that are positive in a pro-forma scenario can become negative once GAAP requirements are applied.
Following GAAP guidelines, a company may, for example, report a net loss for a quarter. But if that loss came as a result of one-time litigation expenses or restructuring, the company may prepare pro-forma statements that show a profit.