Pro forma earnings

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Edwin Schmierer

Many companies often report pro forma earnings during their earnings announcements. Pro forma earnings refer to GAAP income from continuing operations, but excludes non-recurring or transitory items such as discontinued operations, extraordinary items, changes in accounting principles, restructuring charges, etc. In addition, companies increasingly exclude expenses related to non-operating activities such as acquisitions, compensation expense in the form of stock options, research and development expenditures, etc. For example, if Company X acquires Company Y, pro forma earnings for the newly-formed company will indicate the aggregated revenues of the two entities before and after the merger, as opposed to showing solely the increase in revenue of the acquirer.

The primary objective of reporting pro forma earnings is to provide the investment community with an earnings figure that reflects "core" or "quality" earnings since core earnings should have the highest relevance for determining the price of the stock. The obvious criticism is that companies have discretion in differentiating between operating and non-operating activities, which presents opportunities for earnings smoothing.