Important considerations when using non-GAAP measures

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Throughout much of 2016, the focus of the financial world was mostly tuned to political developments around the globe. However, some analysts in the U.S. were also raising alarm bells based on recent overtures from the Securities and Exchange Commission and other regulatory agencies regarding corporate accounting and reporting practices. These changes are still being researched and developed further by major firms around the world but provide great resources for growing companies as they wade into the murky waters of financial regulation.

As noted in an article from the Harvard Law School’s Forum on Corporate Governance and Financial Regulation, the SEC had been making increasingly terse statements regarding corporate use of non-standard accounting practices. Rather than sticking with the internationally recognized Generally Accepted Accounting Principles (GAAP), regulators noticed an uptick in the number of corporations straying to other methods. These include calculations of earnings, assets and liabilities that are not considered GAAP and which tend to include pro forma assumptions or expectations rather than measurable data. These practices together are called non-GAAP measures, and they present a number of challenges to businesses.

Non-GAAP explained

In an article from CFO magazine, contributors Jeff Aughton and Jennifer Burns noted that there are certainly benefits for companies that account and report under non-GAAP measures.

“In some cases, a company may believe that the standard measures associated with GAAP are unable to convey subtle but important nuances that an investor would find relevant and useful,” Aughton and Burns wrote. Some of the most common non-GAAP measures include terms that many finance professionals are still familiar with:

  • Earnings before interest and taxes (EBIT).
  • Earnings before interest, taxes, depreciation and amortization (EBITDA).
  • Adjusted earnings.

Including these metrics alongside the GAAP-recognized figures that investors expect could allow executives to provide broader insights into the company. For example, low bottom-line earnings may concern investors, but this might not be a major issue if the company’s assets are tied up in essential infrastructure like commercial real estate or storage. In this case, EBITDA may give investors a more accurate idea of the company’s financial health.

Many companies report financial data using non-GAAP measures, but they must always be provided in the right context.

Non-GAAP challenges

By their nature, non-GAAP measures are not standard, and therefore could be misunderstood by those who view them without context. With that in mind, the SEC has a long list of strict guidelines regarding the use of non-GAAP measures. Generally, if the SEC or other regulatory body deems a non-GAAP measure “misleading,” that firm could face legal action.

At the same time, simply avoiding non-GAAP measures in financial reports might not be the best course of action either. To give everyone inside and outside the company access to the high-quality reports they need, it’s essential to approach accounting and reporting from a different angle.

Whether using GAAP, non-GAAP or a combination between the two, executives must take care in their accounting and finance strategy by focusing on the following:

  • Quality: Especially for non-GAAP, all data must be of the highest quality, calculated with reliable inputs and necessary controls. Data should also be presented in a logical, easily digestible fashion.
  • Accuracy: All facets of the financial report should match previous versions and internal accounts. The information must also conform to all disclosures.
  • Consistency: Non-GAAP measures must be presented in a consistent manner for each period, along with their requisite disclosures. In addition, the process of reviewing and monitoring accounting practices needs to take place at regular intervals, subject to local and federal laws.

With all this in mind, it’s easy to see why non-GAAP measures may make business leaders and investors equally nervous. Even a small, inadvertent oversight could turn into a very costly mistake. At the same time, startup and fast-growing firms often need to use non-GAAP measures to attract and retain investors.

To bolster accounting and finance practices, businesses are increasingly turning to a partner like Consero. Staying in line with laws and best practices in a complicated field requires a significant time investment, but Consero can make this process much more efficient. By giving their clients the people, processes and technology they need, Consero enables growing companies to accomplish their finance and accounting goals without sacrificing quality or their duty to shareholders and the law.

Learn more about Consero and how they help businesses succeed.

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