A Look at Pro-Forma Earnings

Pro forma earnings statements are not designed to catalogue actual company finances. Instead, they are used to project earnings anticipated from a given project or expansion. Pro forma literally translates to "for the sake of form." Pro forma earnings statements, then, are a way of categorizing potential revenues in an accepted format in order for investors and lenders to understand the projection. Pro forma statements are not designed to replace actual earnings statements or financial reports.

Pro Forma Earnings Example

There are many scenarios when a pro forma earnings statement is useful. For example, Bob's Restaurant currently owns 1,000 square feet of space in a small building. The shop next door just went out of business, and the previous owner is offering Bob's Restaurant the chance to buy out the space next door. Bob needs to determine whether or not purchasing this extra 800 square feet would increase his profits proportionally to the expense of the purchase. He has his financial manager draw up a pro forma earnings statement. The financial manager estimates how much additional income Bob could earn during breakfast, lunch and dinner by adding the additional space and estimates the likelihood the space will be filled with customers. If the pro forma earnings compensate for the expense of the purchase, Bob may ask investors to help him purchase the new space, or he may seek a loan to do so, showing the potential financiers the pro forma statement he used for estimates.  

Inaccurate Pro Forma Earnings  

Pro forma statements are, at the heart, estimates. They should never be used to determine the actual earnings of a company or project at any given time. The key reason they fail to create an accurate pictures is because they are not held to Generally Accepted Accounting Principles. This means the pro forma statement does not need to include all items that may affect the profitability of a venture. For example, amortization, depreciation, interest, taxes and other items may all be left of a pro forma statement. Because these items are left off, the actual profit when the project is realized will almost always be lower than the pro forma estimate. It is in the company owner's best interest to provide an inflated pro forma estimate to encourage investment in his business or project. Lenders and investors alike know the pro forma estimate is a "best case scenario" and not an accurate depiction of revenue.

Purpose of Pro Forma Earnings

If the earnings are not accurate, why do business owners and investors continue to use them? The main point of the pro forma statement is the form itself. It shows potential investors and lenders the key areas where a business hopes to earn revenue in a new project. The statement also shows the reasoning behind this push to grow, expand or restructure. Essentially, a pro forma statement gives a business owner a chance to petition for the company's best interest, showing why this move is a wise decision and why investors should support it.

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