Non-GAAP Measures Can Be Misleading

For instance, a company looking to report EBITDA in its financial statement would also need to provide the reconciliation to report its net earnings as to GAAP. Companies can adopt different ways to track and report financial information to the stakeholders. While in the United States, the companies follow the US GAAP method of accounting.

• While GAAP-related measures are audited by qualified accounting firms, non-GAAP measures undergo no such scrutiny.
• One of the most common forms of non-GAAP measurements in accounting is EBITDA, or earnings before interest, taxes, depreciation, and amortization.
• Adjusted results help to more accurately portray the operations and value of an ongoing business.
• It’s undoubtedly an important question in the minds of managers, investors, bankers, and boards of directors .
• As a result, firms close unremunerative business segments more frequently, sell those assets at a loss, and pay severance to workers.
• In comments on misleading adjustments, the SEC staff often focuses on tailored accounting principles.
• For example, a CEO could postpone the closing of a loss-making business because doing so would reduce his GAAP-based bonus, causing further harm to shareholders.

Also, they must offer reconciliation between the adjusted and regular results, or we can say explain the difference between GAAP vs non-GAAP figures. If a company wishes, it may add supplemental information, such as non-GAAP reports, for more information. This, in turn, helps analysts, shareholders, and other stakeholders to know about the true financial health of the company. The use of non-GAAP earnings for S&P 500 companies has increased from 59% in 1996 to 97% in 2017.

Focus on KPIs

EBITEarnings before interest and tax refers to the company’s operating profit that is acquired after deducting all the expenses except the interest and tax expenses from the revenue. It denotes the organization’s profit from business operations while excluding all taxes and costs of capital. GAAP was developed by the Financial Accounting Standards Board to standardize financial reporting and provide a uniform set of rules and formats to facilitate analysis by investors and creditors. GAAP standardizes financial reporting and provides a uniform set of rules and formats to facilitate analysis by investors and creditors.

• These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.
• The consistency and comparability that should form the basis for financial reporting are therefore compromised as a result.
• Based on the company’s disclosures we estimate that, using a fair value through profit and loss approach, MicroStrategy would have reported a significant increase in value during 2021.
• It generally refers to any accounting method that is not GAAP, meaning measures that don’t follow the set standard calculation.

Companies A and B have identical GAAP net income, but different non-GAAP adjusted EBITDA amounts and adjustments to arrive at such amounts. Either presentation may be acceptable under SEC rules; however, in order for users to fully understand the non-GAAP financial measure, it must be accompanied by transparent disclosure. From the disclosures above, users of this information can clearly understand that the non-GAAP financial measures are calculated differently. Non-GAAP financial measures and KPIs that are calculated consistently period over period can be useful to investors.

GAAP

Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee (“DTTL”), its network of member firms, and their related entities. DTTL and each of its member firms are legally separate and independent entities. DTTL (also referred to as “Deloitte Global”) does not provide services to clients. In the United States, Deloitte refers to one or more of the US member firms of DTTL, their related entities that operate using the “Deloitte” name in the United States and their respective affiliates. Certain services may not be available to attest clients under the rules and regulations of public accounting. In a perfect world, companies would be committed to accuracy on both GAAP and non-GAAP reports. The past has shown us that some companies have used non-GAAP reports to mislead investors.

• The disclosure must include a statement on why management believes the non-GAAP financial measure provides useful information to the investor.
• Indeed, we have previously discussed such adjustments by Tesla in our article ‘Dot-com bubble accounting still going strong’.
• Further, a registrant should not use a reconciling item labeled “other” that includes numerous significant items without clearly disclosing the nature of the items being used, along with the related amounts for each adjustment.
• Is there more to your company’s performance than what GAAP financial reporting reveals?
• Be vigilant in your analysis and move on if a company is being too aggressive — even if the SEC hasn’t done anything about it.
• Losses turning into profits is becoming quite common for firms of all sizes.

Public companies can also report earnings based on their own logic and practices, but non-GAAP reports may not be a substitute for GAAP reports. In some cases the GAAP treatment of this expense and other non-cash expenses could make a company appear to be unprofitable even if it is cash flow positive, affecting how potential lenders and investors evaluate the health of the business. Many young companies, including many in the life sciences industry, do not show a profit for many years as they pour money into research to create products that will generate revenues far into the future.

Frequently Asked Questions

EBITDA, or earnings before interest, taxes, depreciation, and amortization, is a measure of a company’s overall financial performance. Studies have suggested that the exclusion of stock-based compensation from earnings results reduces the predictive power of analyst forecasts, so non-GAAP figures that merely adjust for equity compensation what is gaap are less likely to provide actionable data. Adjusted EBITDA – it is EBITDA without including the cost of stock-based compensation and non-cash charges related to the acquisition in the past. The disclosure must include a statement on why management believes the non-GAAP financial measure provides useful information to the investor.

These other non-GAAP financial measures include free cash flow, net debt, constant currency, tangible common equity, net interest, organic sales growth, and a multitude of financial ratios. Even though Non-GAAP is not a standard method, prescribed formats and standards are not followed, but it is accepted as a reporting method. All public companies should follow GAAP reporting in their accounting as per SEC- securities exchange commission guidelines.

Mind the GAAP

Our disaggregation starts with the ‘profit before separately identified items’ (i.e., non-GAAP profit), which we adjust to obtain the GAAP results. The advantage of presenting it this way is that the separately identified expenses have the correct sign, which we think is less confusing for investors.