Question

What is the concept of pro forma earnings and why has this earnings measure been criticized?

Answer 1

Pro forma earnings are those earnings which are not reported using Generally Accepted Accounting Principles (GAAP). GAAP provides guidelines for the companies to show all costs while reporting their earnings, however Pro forma earnings provides discretinary powers in the hands of the enity reporting the earnings regarding the costs that are to be included while caluclting their earnings. It allows companies to exclude some of the costs that the company think should not be included in order to report normalised profit. The costs that are usually excluded are the non recurring costs which are not incurred frequenlty and are mostly one time costs for example, acquisition related costs.

These earnngs are criticized for the main reason that it allows the entity reporting these earning to manipulate the numbers in its own favour. The company might show a healthy picture of its earnings by not disclosng the important costs and thus it can misguide the investors. So every investor before taking decision on the basis of these earnings must check for the costs that are excluded while calculating pro forma earnings and then take decision.