Introduction of Pro-Forma Earnings
Pro-forma earnings are those earnings which are calculated using certain projections or estimations or presumptions about the future prospects of the company, which may not be in compliance with the generally acceptable principles of accounting & which are used for securing bank finance or using internally for the purpose of decision making by the management.
- Pro-forma means “as a matter of form.”
- Pro-forma earnings are estimated using recurring events occurring in the entity on a year-on-year basis & thus, it ignores the non-recurring events such as any restructuring made, disposal of any plant of the organisation, etc.
- Both positive, as well as negative non-recurring events are ignored for the purpose of presentation.
- Thus, we can say that such a statement does not comply with the generally accepted accounting principles.
- The non-inclusion of exceptional items in Pro-forma earnings is that we cannot project the exceptional events in the future.
- Thus, pro-forma earnings can be referred to as earnings in the normal situation of the company (i.e., the demand for sales remains the same).
- Also, the company has to specify pro-actively that pro-forma figures are unaudited.
Examples of Pro-Forma Earnings
Different examples are mentioned below:
Pro-Forma Statement of Operations (unaudited)
For Three-Months Ended December 31, 2019
|Particulars||December 31, 2019|
|Reported Figures ($) Millions||Adjustments ($) Millions||Pro-Forma Figures ($) Millions|
|Cost of Goods Sold||1,01,508||–||1,01,508|
|Gross Profit (A)||1,38,950||-45,000||93,950|
|Employee Benefit Costs||15,000||1,350||16,350|
|Sales, General & Administrative costs||12,500||–||12,500|
|Depreciation on tangible assets||14,523||–||14,523|
|Amortisation of intangibles||16,800||-16,800||–|
|Loss due to dismantling of assets||35,000||-35,000||–|
|Loss due to earthquake||3,500||-3,500||–|
|Foreign Exchange loss||1,456||-1,456||–|
|Shifting of factory (relocation expenses)||986||-986||–|
|Subtotal expenses (B)||1,06,115||-59,492||46,623|
|Pro-forma earnings (A-B)||32,835||47,327|
- The company has excluded the non-operating income from its pro-forma earnings figure due to its non-recurring nature. The company can earn a discount due to higher-order on procurements or settlement claims with vendors, etc.
- The company has added $ 1350 million on a net basis to the employee cost on the submission that the number of employees will increase in the near future.
- It has excluded $ 850 million stock compensation using the assumption these are non-recurring in nature.
- Further, loss due to the dismantling of assets is excluded due to the assumption that the company will not dismantle the assets in the future.
- Loss due to earthquake cannot be recurring in nature & hence, excluded.
- Foreign exchange gain or loss depends on foreign dealings & thus company does not want to project on uncertain events.
- Further company has assumed that 50% of other expenses are non-recurring in nature.
- On a gross basis, you can observe that due to such adjustments, the company has managed to increase the Pro-forma earnings from $ 32835 million to $ 47327 million even if its total revenue has been reduced by $ 45000 million.
Uses of Pro-Forma Earnings
- Pro-forma earnings represent the normal scenario of company performance over the period.
- Investors can look upon on the company in a better position.
- Pro-forma earnings can be used internally by the management for the sake of decision-making.
- The management can also see the effect of change in a single assumption & can decide accordingly.
- The exclusion of non-recurring events helps investors understand the core business process & normal process of the company in a clean environment.
- Pro-forma earnings can also be presented to a financial institution for securing bank finance or cash credit facilities.
- Companies can also attract investors in the company by certifying the assumptions used in the preparation of Pro-forma statements. This increases the confidence of the investors.
- It helps in the computation of the projected EPS after a merger deal or for analysing the merger situation on the company’s share price.
- Investors also use pro-forma earnings for the purpose of analysing the risk involved in the business of the company.
Benefits of Pro-Forma Earnings
Some of the benefits are given below:
- It represents the normal scenario of the company since exceptional situations are already excluded while preparation.
- It can also be viewed as a budgeted statement or target statement to be achieved by the organisation.
- It ensures the minimum performance guarantee by the company in future years.
- Sometimes, it may happen that no exceptions have occurred & Pro-forma results may happen to be actual results of the company.
- It helps companies to identify the introduction or deletion of a product line into the business.
- In the long run, the company can also use these statements as back-projection to identify where the assumptions used at that time were appropriate.
- Pro-forma earnings are presented in Pro-forma financial statements. Thus, estimation is made for both earnings as well as expenses.
Disadvantage of Pro Forma Earnings
Some of the disadvantages are given below:
- The biggest disadvantage is that why would a company show the negative prospects of its operations in the future. This biasness reduces the sensitivity with respect to figures reported in the pro-forma financial statements.
- We can say the management can easily manipulate the pro-forma earnings with the intent to show only the positive side of earnings.
- Such earnings negate the existence of exceptional events that may occur in the future. Thus, few companies exclude the exceptional events even if they have evidence of the exception occurring today.
- There is no accounting standard specified for the computation of pro-forma earnings. Thus, the computation is free at the discretion of the management.
- Even if investors may appoint a third party to certify the figures, such a third party can also provide reasonable assurance on the assumptions used in the computation of pro-forma earnings.
- Another disadvantage is that it’s not mandatory for companies to report the Pro-forma earnings every year & you may not get the continuous reports every year.
- The actual earnings are always lower than the pro-forma earnings due to the exclusion of non-recurring expenses & inclusion of normal revenue.
Pro-forma earnings represent the assumptions used at arriving at the figures. These assumptions reflect the basis of the figures. Few assumptions also reflect the mentality of the management in arriving at the figures. Therefore, it may differ from the actual performance of the company. Also, pro-forma statements are mandated by any regulation & there is no specific format of presentation & thus, the presentation may vary from one company to another.
This is a guide to Pro-Forma Earnings. Here we also discuss the introduction and example of pro-forma earnings along with benefits and disadvantages. You may also have a look at the following articles to learn more –