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.
Pro-Forma Earnings Definition
Pro-Forma earning refers to earning that excludes non-recurring items like restructuring charges, extraordinary items. In Pro-Forma Earning company’s earnings are not calculated according to Generally Accepted Accounting Principles (GAAP). It is used to show the positive aspect of earning.
- Pro-Forma earnings also refer to as projection of earning that includes as a part of IPO i.e. Initial Public Offering.
- Pro-Forma Earnings Company may exclude item that is non-recurring or that normally not occurs as a part of normal operations. Examples are asset impairments, obsolete inventories, restructuring charges, and extraordinary items. The intention of a company through these is to create a clear picture of its normal profitability and show it to investors.
- Moreover, some companies misuse this and exclude item that should normally include as per GAAP. An investor should take precaution, do fundamental analyses and invest accordingly.
Pro-Forma Earnings Case Study
Let us understand the same with a case study.
In 2001, Amazon.com has 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 loss as per GAAP was at $170 million. Then controversy arose which made the company develop report 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 Resort.
What is Pro-forma EPS?
It also helps to find Pro-Forma Earnings per share known as Pro-Forma EPS. This calculation is based on normalized, net income that excludes non-recurring expenses. Pro-Forma EPS aim is to find the stream of earnings from core operations, which can be used to forecast future EPS.
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Pro-forma EPS is very helpful in Mergers and Acquisitions wherein Pro-Forma EPS adds the target net income and any additional synergies or incremental adjustments to the numerator while adding new shares issued sue to acquisition to the denominator.
Pro-Forma EPS Formula
- Pro-Forma EPS is used by acquiring a company to determine financial outcome they will have by acquiring the target or merger with the target. This also allows the acquirer to determine whether this transaction will be accretive or dilute, and cause a positive effect in EPS. This situation can also arise where Earnings Per Share can increase, but the value of merger companies is lower than the acquirer and target.
- Please note Incremental Adjustment are additional value item that is created when two companies merge.
- For example, an E-commerce company merges with the courier company. Through this merger, e-commerce company can save its original courier cost, which was paid to third party courier company earlier. With this company is using its own resources which leads to an increase in profit and reduce cost.
How to Calculate Pro-Forma Earnings per Share (EPS)?
Let’s calculate Pro-Forma EPS in this merger.
A calculation is as follows: –
The acquirer has total earning of $ 6000 and shares outstanding of 3,000.
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 share 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 EMS will be:
- Accretion/ Dilution is the percentage in EPS after the transaction of before.
- Accretion/ Dilution= (2.43-2)/2*100
- Accretion/ Dilution
Accretion means positive and dilution means negative.
You can download this Pro-Forma Earnings Excel Template Here:- ProForma Earnings EPS Calculations Excel Template
GAAP vs Pro-Forma Financial Statements
- GAAP give 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 help one to find 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 same can be manipulated.
Use of Pro-Forma Earnings Statements
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. Pro-Forma Earnings can either exceed or fall short of a normal earnings report, they are normally reported when Pro-Forma Earnings exceeds by actual performance.
Advantages of Pro-Forma Earnings
- Pro-Forma EPS also give an investor a clear picture of company operations. For some company, it provides an accurate view of financial performance and looks out of a company.
- Considering non-recurring expense affect investors view but these expenses are of short-term and for long-term profit earning need to be calculated through Pro-FormaEPS in which these expenses are not considered and help to analyze long-term profit. Example: Charges of a merger of a company is one time hence, not consider in Pro-Forma EPS.
- These Earnings are a useful tool to identify companies core value driver and analyze changing trend within company operation which later could be used to a valuation of potential takeover targets.
Disadvantages of Pro-Forma Earnings
- Company sometime excludes things like stock-based compensation and acquisition-related expense and they expect an investor to consider these expenses as non-real and also consider earnings in positive.
- These Earnings does not have any standard guideline to follow
- Some companies do not consider unsold inventories in a statement
- These Earnings can be easily manipulated.
This has been a guide to what is Pro-Forma Earnings. Here we discuss practical examples of Pro-Forma Earnings, how to calculate Pro-forma EPS along with the advantages and disadvantages of Pro-forma. You may learn more about Financial Statements from the following articles –
- Cash Flow Statement | Top 4 Examples
- How is Interest Expense Recorded in Income Statement?
- Types of Pro Forma Income Statement
- Types of Pro Forma Financial Statement
- Acquisition Premium Takeover
- Example of Pro Forma Cash Flow Statement
- Incremental IRR
- Net Income Calculator
- What is Earnings Season?
- Quality of Earnings
- EBITDA Interpretations
- What is Appropriated Retained Earnings?