What it means
Reported earnings follow accounting standards and include every item of income and expense. Pro forma earnings start from that reported figure and then add back or strip out items that the company says will not recur.
Common adjustments include restructuring charges, costs of an acquisition, legal settlements, write-downs of assets and gains from selling a business. Some companies also exclude share-based pay or the amortisation of acquired intangible assets, which is more controversial.
Used well, the figure helps analysts compare one year with another without distortion from one-off events. A company that closed a factory and booked a large charge may be performing perfectly well on its normal activities, and the adjusted number shows that more clearly.
Used badly, it can flatter results. If a firm excludes charges every year, they are not really one-off, and the pro forma figure can drift far from the cash and profit the owners actually experience.
Regulators in several countries require companies to reconcile pro forma earnings to the official figure and to avoid giving them more prominence. Investors and lenders should always look at both numbers and ask whether the excluded costs return in the following year, since a cost that keeps coming back is part of running the business.
A useful test is to ask whether the cost is truly unrelated to running the business. If a cost arises in most years, it is part of doing business, whatever label management gives it.
In practice
Real-world examples.
Example
A manufacturer closes a plant and records a $5,000,000 charge for redundancy payments. It presents pro forma earnings without the charge to show underlying profit. Analysts compare the figure with last year, but they also note the charge in the official accounts. They ask whether the closure will really save money in later years.
Example
A software company buys a smaller rival and pays $800,000 in advisers' fees. The fees are excluded from pro forma earnings as a one-off. The finance team reports both figures to the board. The board sees the reconciliation so that nobody mistakes the adjusted number for the official one.
Example
A retailer sells a warehouse for a gain of $3,000,000. Its pro forma earnings remove the gain because selling property is not part of its normal trading. Without the adjustment the year would have looked unusually strong. Lenders reading the figure would then have assumed that profit of that size could be repeated.
Formula
Calculation
Pro forma earnings = reported net income + one-off costs after tax - one-off gains after tax
Pro forma earnings per share = pro forma earnings / number of shares
Suppose a company reports net income of $8,000,000 on 5,000,000 shares, so reported earnings per share are 8,000,000 / 5,000,000 = $1.60.
It booked a restructuring cost of $2,000,000 before tax. With a tax rate of 25%, the after-tax effect is 2,000,000 x (1 - 0.25) = $1,500,000.
Pro forma earnings = 8,000,000 + 1,500,000 = $9,500,000.
Pro forma earnings per share = 9,500,000 / 5,000,000 = $1.90, which is $0.30 higher than the reported figure.Case study
Seen in the real world.
Lakeside Devices is an illustrative, fictional electronics company that reported net income of $12,000,000 for the year. The board presented pro forma earnings of $15,000,000, after excluding $4,000,000 of restructuring costs, which after a 25% tax rate became $3,000,000.
An investor looked at earlier years and found that Lakeside had excluded restructuring costs in each of the past four years, with amounts between $2,000,000 and $5,000,000. She concluded that restructuring was a normal part of the business and valued the company on the reported figure instead.
In this illustrative story she paid a lower price than the pro forma figure would have suggested, saving herself roughly 20% on the purchase. The lesson is that one-off items that appear every year deserve scepticism, and that the reconciliation table is often the most valuable page of a results announcement.
Watch out
Common mistakes.
- Taking pro forma earnings at face value without reading the reconciliation to reported earnings, which is where the excluded items are listed.
- Accepting that a cost is one-off when it has appeared in several years in a row.
- Forgetting to adjust for tax, which overstates the effect of the excluded cost because a cost that reduces profit also reduces the tax bill.
Questions
People also ask.
Are pro forma earnings the same as adjusted earnings?
The terms are often used interchangeably, and both describe profit with certain items removed, though definitions vary between companies.
Are pro forma earnings allowed?
Yes, but in many places the company must present the reported figure with equal or greater prominence, reconcile the two numbers and explain why the adjusted figure is useful to investors.
Why do companies publish them?
They argue the figure shows the underlying performance more clearly, though critics say it can make results look better than they were, especially when the same costs are excluded year after year.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%