What are non-GAAP benefits?
Non-GAAP profits are an alternative accounting method used to measure a company’s profits. Many companies report non-GAAP profits in addition to their profits under generally accepted accounting principles (GAAP). These pro forma figures, which exclude “one-time” transactions, can sometimes provide a more accurate measure of a business’s financial performance from direct business transactions.
However, investors should beware of the potential for misleading disclosure by a business, which excludes items that have a negative effect on GAAP earnings, quarter after quarter.
Understanding the non-GAAP benefits
To understand the non-GAAP benefits, it is important to understand the GAAP benefits. GAAP profits are a common set of standards accepted and used by businesses and their accounting departments. GAAP profits are used to normalize the financial reporting of listed companies.
The rationale for reporting non-GAAP profits is that significant exceptional costs, such as asset write-downs or organizational restructuring, should not be considered normal operational costs as they distort the true financial performance of a business. . Consequently, some companies provide adjusted sales that exclude these non-recurring items. Commonly used non-GAAP financial measures include earnings before interest and taxes (EBIT), earnings before interest, taxes, depreciation and amortization (EBITDA), adjusted revenue, free cash flow, basic earnings and operating funds.
When used appropriately, these non-GAAP financial measures can help companies provide a more meaningful picture of their performance and value. Presenting only the financial results of the core activities can be helpful. However, there are no regulations regarding non-GAAP earnings per share. Many of these adjusted EPS figures are simply designed to appear in securities and deceive trading algorithms, as well as for investors.
Key points to remember
- Non-GAAP profits are an alternative accounting method used to measure a company’s profits.
- Non-GAAP profits are pro forma figures, which exclude “one-off” transactions, such as organizational restructuring.
- Non-GAAP profits can sometimes provide a more accurate measure of a business’s financial performance from direct business operations.
- Investors should beware of possible misleading information from companies that exclude items that adversely affect GAAP results.
Non-GAAP Benefits Review
The quality of a company’s profits is important, so investors should consider the validity of non-GAAP exclusions on a case-by-case basis to avoid being misled. Studies have shown that adjusted figures are more likely to exclude losses than gains. GAAP profits are now considerably lower than non-GAAP profits, as companies become dependent on “one-off” adjustments, which lose all meaning when they occur every quarter. Merck, for example, turned a loss of – $ 0.02 per share under GAAP into “adjusted” earnings of $ 1.11 per share in the fourth quarter of 2020, a difference of 5,650%.
Investors should therefore be careful not to lose sight of GAAP profits. Standardized accounting rules are in place to ensure consistency and comparability. Constant revenue recognition makes reported profits more reliable for historical comparison and allows investors to compare a company’s financial results to those of its peers and industry competitors. This is why the Securities and Exchange Commission (SEC) obliges listed companies to use GAAP accounting in the first place.
US companies are under increasing pressure from the SEC to disclose GAAP earnings in their earnings reports straight away, before reporting non-GAAP earnings.
The SEC has started to take coercive action against abusive practices where companies place more importance on non-GAAP figures than on GAAP figures. Technology companies are among the most frequent abusers of non-GAAP EPS because they use a significant amount of stock compensation and have significant asset impairments and R&D costs.