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Pro-Forma Earnings

Updated on January 4, 2024
Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

Pro-Forma Earnings Definition

Pro-Forma Earnings refers to the company’s income that is calculated in deviation from the compliance with the Generally Accepted Accounting Principle as it does not take into account non-recurring items such as extraordinary items like loss due to fire, restructuring expenses, etc. so that the company can show a relatively positive picture of company’s financial statement.

In simple words, Pro-Forma earning exclude non-recurring items like restructuring chargesNon-recurring Items Like Restructuring ChargesNon-recurring items are income statement entries that are unusual and unexpected during regular business operations; examples include profits or losses from sale of asset, impairment costs, restructuring costs, and losses in lawsuits, and inventory write-off.read more and extraordinary items. It is used to show the positive aspect of earning. In this, the company’s earnings are not calculated according to Generally Accepted Accounting Principles (GAAP).

Case Study

Let us understand the same with a case study.

Pro Forma Earnings Amazon

source: amazon.com

In 2001, Amazon.com released a Pro-Forma result of a quarter, excluding some expenses like write-downs of impaired assetsImpaired AssetsImpaired Assets are assets on the balance sheet whose carrying value on the books exceeds the market value (recoverable amount), and the loss is recognized on the company's income statement. Asset Impairment is commonly found in Balance Sheet items such as goodwill, long-term assets, inventory, and accounts receivable.read more, interest expenses, and losses on equity investments.

As per Amazon.com, Pro-Forma operating loss narrowed to $27 million for the third quarter, whereas net lossNet LossNet loss or net operating loss refers to the excess of the expenses incurred over the income generated in a given accounting period. It is evaluated as the difference between revenues and expenses and recorded as a liability in the balance sheet.read more per GAAP was $170 million. Then controversy arose, which made the company develop reports per Pro-Forma standards and release reports. In late 2001 the Securities and Exchange Commission warned that if any company misled Pro-Forma, earnings could face civil fraud suits. In 2002 first action against this warning was taken over Trump Hotels and Casino Resorts.

What is Pro-forma EPS?

It also helps to find Pro-Forma EPS. This calculation is based on the normalized net income that excludes non-recurring expenses. Pro-Forma EPS aims to find the stream of earnings from operations, which can be used to forecast future EPS.

Pro-forma EPS is very helpful in Mergers and AcquisitionsMergers And AcquisitionsMergers and acquisitions (M&A) are collaborations between two or more firms. In a merger, two or more companies functioning at the same level combine to create a new business entity. In an acquisition, a larger organization buys a smaller business entity for expansion.read more. It adds the target net income and any additional synergies or incremental adjustments to the numerator while adding new shares issued due to acquisition to the denominator.

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Pro-Forma EPS Formula

Pro-Forma EPS Formula

How to Calculate Pro-Forma Earnings per Share (EPS)?

ParticularsAcquirerTargetAdjustPro Forma
Earnings ($)$600030009000
Earning (in shares)30007003700
EPS ($/Share)$22.43
Accertion/Dilution21.50%

A calculation is as follows: –

The acquirer has total earnings of $ 6000 and shares outstanding of 3,000.

EPS =6000/3000

Pro-Forma EPS example1.1

The target company being acquired has total earnings of $ 3,000.

Adjust is when the acquirer issues 700 new shares and hands them over to the target to complete the acquisition.

Pro Forma is the sum of all earnings divided by all shares outstanding to get Pro Forma EPS.

  • Pro Forma EPS = (Acquirer’s Net Income + Target’s Net Income)/(Acquirer’s shares outstanding + New Shares Issued)
  • = (6,000+3,000)/(3,000+700)
Pro-Forma EPS example1.2

Pro Forma EMS will be:

Pro-Forma EPS example1.3
  • Accretion/ Dilution is the percentage in EPS after the transaction or before.
  • Accretion/ Dilution= (2.43-2)/2*100
Pro-Forma EPS example1.4
  • Accretion/ Dilution
Pro-Forma EPS example1.5

AccretionAccretionAccretion primarily means gradual or incremental growth. However, with respect to finance, it has the following technical meaning: 1) Bond Markets 2) Merger and Acquisitionsread more means positive, and dilution means negative.

You can download this Excel Template Here:- ProForma Earnings EPS Calculations Excel Template

GAAP vs. Pro-Forma Financial Statements

  • GAAP gives details of every expense company has faced, whereas Pro-Forma excludes non-recurring expenses
  • GAAP cannot analyze long-term profit, whereas Pro-Forma helps one find a company’s long-term profit.
  • When GAAP shows earnings in the negative, Pro-Forma earnings can be positive.
  • GAAP cannot be manipulated expenses, whereas for Pro-Forma, earning the same can be manipulated.

Uses

Pro-Forma Earnings Statement provides a better look at the performance and value of a company’s core business. Mostly non-recurring business events can be excluded because it will be expected that they will not occur in the future.

Advantages

  • Pro-Forma EPS also gives an investor a clear picture of company operations. For some companies, it provides an accurate view of financial performance and looks out for a company.
  • Considering non-recurring expenses affect investor’s view, but these expenses are of short-term and long-term profit-earning need to be calculated through Pro-Forma EPS in which these expenses are not considered and help to analyze long-term profit. Example: Charges of a company’s merger are one-time; hence, they are not considered in Pro-Forma EPS.
  • These Earnings are a useful tool to identify the company’s core value driver and analyze changing trends within company operation, which later could be used for a valuation of potential takeover targets.

Disadvantages

This article has been a guide to what Pro-Forma Earnings is. Here we discuss practical examples of Pro-Forma EPS calculations and the advantages and disadvantages. You may learn more about Financial Statements from the following articles –

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