Pro Forma Financial Statement

A pro forma financial statement is a financial statement prepared on the basis of assumptions, to show what a company's results or financial position would have looked like if a specific transaction had occurred at an earlier date, or what they are expected to look like in future. The Latin phrase pro forma means "as a matter of form." Pro forma statements are commonly prepared for acquisitions, disposals of a business, initial public offerings, major refinancings and business plans.

Pro forma statements are not a substitute for historical financial statements prepared under GAAP or IFRS. They are supplementary illustrations, and their usefulness depends on how reasonable and clearly disclosed their assumptions are. The term should not be confused with a pro forma invoice, which is a preliminary bill used in trade.

• Transaction pro formas: historical statements adjusted to show the effect of a completed or probable acquisition, disposal or financing, as if it had occurred at the start of the period (for the income statement) or at the balance sheet date (for the balance sheet).
• Projected or forecast pro formas: forward-looking income statements, balance sheets and cash flow statements used in budgets, business plans and loan applications, much like a budgeted income statement and budgeted balance sheet.
• Pro forma or "adjusted" earnings: company-defined measures that exclude certain items, such as restructuring costs or amortization, from reported results. These are regulated as non-GAAP measures.

A software company whose stand-alone results for the year, excluding the deal, are revenue of $120,000,000 and net income of $15,000,000 acquires a smaller rival on 1 October for $80,000,000, funded with a new 7 percent term loan. The rival had annual revenue of $30,000,000 and net income of $3,000,000. To show the combined business for the full year as if the deal had happened on 1 January, a pro forma income statement adds the rival's full-year results and makes adjustments:

• Interest on the $80,000,000 loan for the full year: $5,600,000.
• Amortization of acquired intangible assets identified in the purchase price allocation, say $4,000,000 a year.
• The tax effect of these adjustments at 25 percent, a benefit of $2,400,000.

Pro forma net income is:

Here $\text{NI}_{A}$ and $\text{NI}_{B}$ are the net incomes of the acquirer and target, $\text{Adjustments}$ are the pre-tax pro forma adjustments and $t$ is the tax rate. The result is $15,000,000 plus $3,000,000 minus $9,600,000 times 0.75, which is $18,000,000 minus $7,200,000, or $10,800,000, and pro forma revenue is $150,000,000. The figures show investors that, on a full-year basis, the deal dilutes profit because of financing and amortization costs.

In the United States, the Securities and Exchange Commission (SEC) requires pro forma financial information under Article 11 of Regulation S-X when a registrant completes or plans a significant acquisition or disposal, or in an initial public offering where the business has changed significantly. Amendments effective in 2021 require "transaction accounting adjustments" reflecting the accounting for the deal and allow optional disclosure of management's expected synergies, clearly separated. Under IFRS-based regimes, rules are set by securities regulators, such as the European prospectus rules. Pro forma adjusted earnings in press releases and filings are governed by SEC Regulation G and Item 10(e) of Regulation S-K, adopted in 2003 after the dot-com era, when some companies' pro forma figures excluded so many costs that they bore little relation to reality. These rules require a reconciliation to the nearest GAAP measure, such as net income, with equal or greater prominence for the GAAP figure.

Lenders, investors and boards use pro forma statements to evaluate mergers and acquisitions, financing plans and new ventures. Readers should check what has been adjusted and why, whether synergies are assumed, and whether recurring costs have been labeled as one-off. Adjusted measures such as EBITDA are useful but can overstate performance when companies exclude real costs, such as share-based compensation, from their pro forma figures.