What are 'Non-GAAP Earnings'
Non-GAAP earnings are an alternative method used to measure the earnings of a company, and many companies report non-GAAP earnings in addition to their earnings as calculated through generally accepted accounting principles (GAAP). Some managers believe that these alternate figures provide a more accurate measurement of the company's financial performance.
BREAKING DOWN 'Non-GAAP Earnings'Some common examples of non-GAAP earnings measures are cash earnings, operating earnings and earnings before interest, taxes, depreciation and amortization (EBITDA).
If a company issues securities to the public, the Securities and Exchange Commission (SEC) requires the firm to use GAAP accounting for the financial statements. The statements must also be audited to determine if the financials conform to GAAP requirements. These requirements are in place to ensure that financial statements of public companies are comparable, which allows analysts and investors to make informed decisions about the business.
Examples of GAAP Accounting
Several principles serve as the basis for GAAP accounting, including accrual basis accounting and revenue recognition policies. The accrual basis of accounting matches revenue earned with the expenses incurred to produce the revenue, and the accrual basis method does not post revenue and expenses based on the movement of cash. GAAP insists on the accrual method, because the financial statements are a better indicator of the true earnings of a company if revenue and expenses are not based on cash movements.
GAAP also requires businesses to create policies for recognizing revenue in financial statements, and that the policies must be consistently applied. Companies can recognize revenue when a product is shipped, when a customer receives an invoice or not until the client’s payment is received. To avoid financial manipulation, a business should apply the revenue recognition policy consistently from one month to the next, and it should disclose the policy in the footnotes to the financial statements. Using a consistent policy means that the earnings reported each month are more reliable.
Instances Where Non-GAAP Accounting Is Used
A company uses non-GAAP earnings to emphasize the firm’s cash flow, which is why (EBITDA) is presented in the financials. Depreciation and amortization do not affect cash, so using EBITDA provides an earnings number that excludes these non-cash expenses.
How Earnings Are Reconciled
If a firm presents EBITDA in the financial statements, the firm must provide a reconciliation that explains the difference between EBITDA and GAAP earnings, so that the financial statement reader can understand the differences. Using depreciation expense as an example, a business lists EBITDA less depreciation expense to arrive at GAAP earnings.