The most useful metric to gauge a company’s performance is not necessarily net income, pre-tax profits, or earnings per share, as defined under U.S. Generally Accepted Accounting Principles (GAAP). In some industries, investors and lenders turn to non-GAAP measures for additional information.
Before relying on non-GAAP metrics, however, it is important to understand what is included and excluded to avoid making misinformed investment decisions. Here are the upsides and potential downsides of using non-GAAP information.
Over the years, the use of non-GAAP measures has grown. Some investors and executives argue that certain unaudited figures provide a more meaningful proxy of financial performance than customary earnings figures reported under GAAP.
One popular example is earnings before interest, taxes, depreciation, and amortization (EBITDA). Many investors argue that EBITDA approximates a company’s net cash flow available for lenders and investors over the accounting period.
In recent years, however, some companies have manipulated EBITDA figures by excluding certain costs, such as stock or options-based compensation, that are plainly a cost of doing business. This trend has made it difficult for investors and lenders to make fair comparisons and understand the items taken out.
Some public companies include EBITDA figures and other non-GAAP measures in earnings releases, investor presentations and the management, discussion and analysis section of their financial statements. These unaudited figures may be cherry-picked to paint a stronger financial picture than the one presented in their audited financial statements. In turn, these companies may see their stock prices go up when the earnings are announced three to four weeks before audited financial statements are filed with the Securities and Exchange Commission (SEC).
A balanced approach
One thing is certain: Non-GAAP measures are under greater scrutiny by the SEC and other regulatory bodies. So, companies that decide to disclose such information should exercise caution and avoid making claims that could potentially mislead investors and lenders. Need help responsibly reporting non-GAAP figures for your company? We can help.