Things to Know About Pro Forma EBITDA and Its Benefits
An expected financial statement for a particular period of time that includes certain catalysts and events occurred during that period and used for selling or buying a business is known as Pro Forma. Normally it is used to calculate earnings before interest, taxes, depreciation, and amortization or EBITDA or revenue for a period of 12 months. The entry of a fresh market or the addition of a fresh product during that period is the catalyst on which the buyers focus on calculating the Pro Forma EBITDA TTM and to assume the possible EBITDA during 12 months when a fresh product was launched.
What is ProForma EBITDA?
The buyers usually calculate the free flow of cash and the rate if EBITDA or earnings before interest, taxes, depreciation, and amortization while assessing the worth of the business available for sale. For this purpose buyers usually us the projected Pro forma of a growing business to normalize infrequent EBITDA or assessing the effect of the changes occurred during that period.
For instance, if $5.0 million is the TTM EBITDA target of a company but they have introduced a fresh product nearly four months ago which has increased its EBITDA by $200,000 every month. However, due to monthly expenses of $25,000, the company has closed its unit at that location after six months. Then the pro forma TTM EBITDA will be calculated by the buyer at $6.75. In this way, the pro forma EBITDA of the company for sale will include $1.6 million contributed by the new product to the earnings of the previous eight months. It helped the company to save overheads up to $150,000 in six months prior to the closure of the office.
Benefits of analyzing Pro-Forma EBITDA
As discussed above, an investor can get a clear picture of the operations of a company through the figures show in its Pro forma EBITDA. In some cases, they can know about the nature of the business and financial performance of the company concerned more accurately with the help of its pro forma earnings. Pro forma reports are used more in certain companies to show the characteristics of their industry. A significant amount of one-time charges are borne by a company when it undergoes a merger or a considerable restructuring. Such expenses can unfairly affect the short-term profits of that company as they are not considered as ongoing costs. The investor can analyze the pro forma earnings of the company more appropriately while evaluating its long term potentials by excluding the expenses that are non-recurring.Investment banks and corporate managers also prepare and use pro forma financial statements to evaluate the future operating costs of their businesses as well as to help in evaluating their potential for the targeted takeovers.
In this way, pro forma EBITDA is a useful tool that can be used to analyze the changes in the operations of a company and identify the drivers of its core value. The information provided by the pro forma earnings can help in clarifying the things when a large amount of goodwill and asset depreciation is blurring the official earnings of a company.