Pro-Forma Earnings

Pro-Forma Earnings Definition

Pro-Forma Earnings refers to the company’s income that is calculated in deviation from the compliance with 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 relatively positive picture of company’s financial statement can be shown by the company.

In simple words, Pro-Forma earning refers to earning that excludes 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, extraordinary items. In this, the company’s earnings are not calculated according to Generally Accepted Accounting Principles (GAAP). It is used to show the positive aspect of earning.

Case Study

Let us understand the same with a case study.

Pro Forma Earnings Amazon

source: amazon.com

In 2001, Amazon.com released it a Pro-Forma result of a quarter, which was excluding some expenses like write-downs of impaired assets, 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 as per GAAP was at $170 million. Then controversy arose, which made the company develop reports as per standards of Pro-Forma and release report. In late 2001 the Securities and Exchange Commission issued a warning if any company misleads Pro-Forma earnings could face civil fraud suits. In 2002 first action against this warning was taken over Trump Hotels, 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 Acquisitions; wherein 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.

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 the acquirer issues 700 new shares and handing them over to the target to complete the acquisition.

Pro Forma is the sum of all earning divided by the sum of 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 of 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 each, and every expense company had faced whereas Pro-Forma excludes non-recurring expenses
  • GAAP unable to analyze long-term profit, whereas Pro-Forma helps one to find the long-term profit of a company.
  • When GAAP show earning in negative Pro-Forma earning 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 it 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 of 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 merger of a company are one time; hence, not consider 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 to a valuation of potential takeover targets.

Disadvantages

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

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