U.S. Generally Accepted Accounting Principles (GAAP) is widely perceived as the “gold standard” in financial reporting. Public companies are required to issue GAAP financial statements. A recent survey found that most private businesses also follow GAAP, though some use carve-outs for certain complex rules, such as the lease guidance.
However, you might want to supplement your GAAP financials with non-GAAP metrics. Doing so can help stakeholders better understand your operations, profitability and cash flow. Here’s how to ensure consistency and transparency when using these supplemental metrics.
Why non-GAAP measures matter
GAAP is a set of rules and procedures that accountants typically follow to record and summarize business transactions. These guidelines provide the foundation for consistent, fair and accurate financial reporting. Businesses that issue GAAP financial statements use the accrual method of accounting. Under this method, revenue is recognized when earned (regardless of when cash is received), and expenses are recognized when incurred (not necessarily when bills are paid). Lenders and investors often prefer GAAP financials because they make it easier to compare your financial results over time and with those of other businesses.
Over the years, the use of non-GAAP measures has grown. Beyond helping your management team understand your financial results, these supplemental measures can be useful when applying for financing and evaluating mergers and acquisitions. In fact, some investors and executives argue that certain unaudited figures provide a more meaningful proxy of financial performance than customary earnings figures reported under GAAP. Before relying on non-GAAP metrics, it’s important to understand what’s included and excluded to avoid making misinformed business decisions.
A closer look at EBITDA
One popular example of a non-GAAP metric is earnings before interest, taxes, depreciation and amortization (EBITDA). It was developed in the 1970s to help investors project a business’s long-term profitability and cash flow. The figure is considered one of the most valuable yardsticks investors use when a business is being bought or sold.
Because non-GAAP measures aren’t governed by a single set of accounting standards, some businesses may calculate EBITDA and related metrics differently, or enhance EBITDA figures by excluding certain costs, such as stock- or option-based compensation, that are plainly costs of doing business.
This trend has made it difficult for investors and lenders to make fair comparisons and understand the items left out. As a result, stakeholders should carefully review how these figures are derived, what adjustments have been made, why those adjustments are needed and how management uses non-GAAP metrics for internal purposes. Transparent, detailed disclosures are essential for reliable comparisons across organizations and industries.
Clarity and consistency
Non-GAAP measures can provide valuable insight into your business’s performance when used alongside traditional financial statements. But they should complement — not replace — GAAP reporting. Contact us for guidance on presenting EBITDA and other non-GAAP metrics consistently and transparently.
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