M&A Term of the Day: What is Pro forma?
The newest addition to our M&A glossary is "Pro Forma", a term often misunderstood and with a negative connotation. In fact, the expression “pro forma” (Latin for “as a matter of form”) is commonly used in many areas including accounting, law, import/export, and government. In the context of Mergers & Acquisitions, the term is mostly used in reference to historical financial statements that are not in line with generally accepted accounting principles such as IFRS, US GAAP, HGB, etc. Pro forma financial statements are usually prepared by the seller’s advisor to better – ideally more correctly – present the object of the M&A transaction (i.e. the company, group of companies or business segment for sale) to the buyer. Pro forma financial statements should also be the basis for any forecasts prepared by the seller. The preparation of pro forma financial statements often includes the elimination of unusual and nonrecurring income statement items (e.g. restructuring charges, sale of major fixed assets) that would otherwise distort past earnings – a process called “normalization”. If the business for sale is composed of more than one company, then pro forma consolidated financial statements may have to be prepared. If the business for sale is not an entire legal entity but a sub-unit, then overhead functions and other carve-out effects need to be considered in the preparation of pro forma (carve-out) financial statements. As an unfortunate fact, pro forma financial statements are often abused to present the company for sale in a more palatable manner. A typical task during the buyer’s due diligence process is therefore to investigate in detail how the pro forma financial statements have been derived and whether all adjustments are justified. Read more in the Glossary Section of mergers-acquisitions.org.
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