Pro forma profits

By Fred McClimans
Network World Fusion, 07/30/01

I read an interesting article in The Washington Post recently that discussed the recent third-quarter earnings numbers for Cisco. The article was trying to make sense of Cisco's dual numbers, both posted in the same financial press release, and the recent trend toward firms reporting "pro forma" financials to the public.

The question is, how much money did Cisco make in its third quarter? Was it a profit of $230 million, or was it a loss of $2.69 billion? If you guessed a profit, you were right. But you'd also be right if you selected a loss. Or what about Compaq's recently reported $67 million pro forma profit as opposed to its $279 million loss? Again, both are correct, sort of.

Confused? So are many people, as a result of today's creative accounting practices. In standard accounting, such as the type used by Cisco and Compaq in their "real" financial filings to the Securities and Exchange Commission, a firm must take into account all aspects of their business, including revenue, expenses, write-offs, charges, etc., in determining if it actually made money or not.

However, many IT firms have adopted "pro forma" accounting practices, where a firm can overlook, or eliminate, any aspects of their financial performance they deem "not material" or core to their operations (in fact, there are no definitions as to what pro forma numbers can or cannot include). They claim that this allows them to highlight the important (i.e., revenue generating) aspects of their business and better reflect the health of the company. But again, pro forma numbers are for "public" consumption only and are not accepted by the SEC as "real" numbers.

So why use pro forma accounting numbers in press releases? It makes a company look better to the general public - especially in a down economic period. Unfortunately, most firms today lead off with their pro forma numbers and then follow (if at all) with their actual financials buried in the bottom of their financial press releases. Some firms (not Cisco or Compaq) don't even bother to define what information is excluded from their pro forma numbers, referring to "various charges and write-offs" as the only clue.

From my perspective, the fact that a company actually took massive charges and/or write-offs is critically important to understanding its overall health. After all, when you invest in, or purchase product from a company, you have to rely upon the entire company, not just the profitable slices.

To be fair, pro forma numbers can sometimes be useful to help a firm restate previous numbers or provide additional guidance on overall numbers. But c'mon guys, when you post your financials, let's try to be up front about the true situation - actual "real" numbers first, sliced-up "pro forma" numbers second. And if you've got the time, how about explaining what those pro forma numbers actually represent?

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Fred McClimans is the managing director of Fearless Ventures and the former CEO/founder of Current Analysis, Inc. Reach him at fred@fredmcclimans.com