UK Accounting Glossary
The term pro forma (occasionally written proforma) comes from a Latin phrase meaning, “as a matter of form”. Its meaning depends on the context in which it is used.
Pro forma financial statements are financial statements that include projections into the future. Interpretation of pro forma financials requires considerable caution. First, the pro forma results are inevitably based upon numerous critical assumptions, many of which may be hidden even if detailed explanatory notes accompany the pro forma financials. Second, GAAP does not encompass such forward-looking estimates. Since pro forma financial statements do not adhere to GAAP anyway, the financial statements may reflect accounting choices that would not be acceptable in practice. Consequently, pro forma financials may (knowingly or unknowingly) misrepresent actual results even if all the underlying assumptions were to prove correct. Nevertheless, no business plan would be complete without detailed pro forma financial statements. Pro forma financial statements are also developed to evaluate potential mergers, acquisitions, and spin-offs. Pro forma is Latin for “as a matter of form.”
Doing something in a pro forma manner is to do it in perfunctory way to satisfy the minimum requirements or to conform to a convention.
A pro forma document is provided in advance of an actual transaction simply to serve as a model for the actual documents of the transaction.
Pro forma refers to court rulings merely intended to facilitate the legal process (to move matters along).
Many companies report pro forma earnings, in addition to actual earnings calculated under the Generally Accepted Accounting Principles (“GAAP”), in their quarterly and yearly financial reports.
The pro forma accounting is a statement of the company’s financial activities while excluding “unusual and nonrecurring transactions” (unusual and nonrecurring expenses) when stating how much money the company actually made. Expenses often excluded from pro forma results include company restructuring costs, a decline in the value of the company’s investments, or other accounting charges, such as adjusting the current balance sheet to fix faulty accounting practices in previous years.
Companies that report a pro forma income statement or balance sheet usually do so because, they say, the unusual events being excluded really were unusual, so the GAAP financial reports required by law are misleading to investors and potential investors. The crisis that happened this last quarter is not going to recur in future quarters, so the pro forma results can be used by investors to forecast what a “regular” quarter might portend in the future.
Critics note that pro forma numbers always look more profitable than GAAP numbers, and state that many companies intentionally use pro forma results in order to mislead investors into believing the company is in much better financial shape than it is; that there is no defined meaning or accounting standard for “pro forma” and that it is therefore impossible to make an “apples to apples” comparison between companies with pro forma results in the way that GAAP accounting allows; and that most “unusual events” reported as such are part of the ordinary course of business and should be reported as such. Most companies in most capitalist countries restructure themselves often, for example, so, it is argued, it is dishonest to claim that restructuring charges are unusual, one-time events that investors should not anticipate in the future.
There was a boom in the reporting of pro forma results starting in the late 1990s, with many dot-com companies using the technique to recast their losses as profits, or at least to show smaller losses than the GAAP accounting showed. The SEC requires publicly-traded companies in the United States to report GAAP-based financial results and has cautioned companies that using pro forma results to obscure GAAP results would be considered fraud if used to mislead investors.
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This glossary post was last updated: 6th February 2020.