Non-GAAP earnings offer an alternative accounting method to measure a company’s earnings, supplementing the conventional Generally Accepted Accounting Principles (GAAP) measures. These pro forma figures, which exclude “one-time” transactions, can sometimes provide a clearer picture of a company’s financial performance based on its core business operations.
However, investors should tread cautiously as companies might use this flexibility for misleading reporting that routinely excludes negative factors impacting GAAP earnings.
Understanding Non-GAAP Earnings
To understand Non-GAAP earnings, one must first become familiar with GAAP earnings. GAAP earnings follow standardized principles accepted and utilized by companies globally to ensure consistency in financial reporting.
Non-GAAP earnings exclude large one-off costs, such as asset write-downs or organizational restructuring, which are not considered part of normal operational costs as they skew the true financial performance of a company. For this reason, companies might report an adjusted earnings number stripping out these nonrecurring items. Common Non-GAAP financial measures include:
- Earnings Before Interest and Taxes (EBIT)
- Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)
- Adjusted Revenues
- Free Cash Flows
- Core Earnings
- Funds From Operations (FFO)
When applied responsibly, these Non-GAAP measures can provide a more meaningful understanding of a company’s true performance by focusing exclusively on its essential business activities. However, the lack of regulation regarding Non-GAAP Earnings Per Share (EPS) means investors must critically assess whether Non-GAAP figures are being fairly represented.
Key Takeaways
- Non-GAAP earnings offer an alternative way to measure a company’s performance.
- These are pro forma figures that exclude “one-time” transactions like organizational restructuring.
- They can sometimes present a more accurate picture of operational performance.
- Investors should beware of potentially misleading exclusion of negative elements in GAAP earnings.
Criticism of Non-GAAP Earnings
Assessing the validity of Non-GAAP exclusions individually is crucial for investors keen on not being misled. Studies show that Non-GAAP adjustments often exclude more losses than gains, making GAAP earnings significantly trail behind. The frequent elimination of “one-time” costs defeats their purpose when such exclusions recur every quarter.
For instance, in the fourth quarter of 2017, Merck converted a GAAP loss of $0.02 per share into an
Related Terms: GAAP, EPS, EBITDA, cash flows, financial measures.
References
Get ready to put your knowledge to the test with this intriguing quiz!
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## What does "Non-GAAP earnings" stand for?
- [ ] Generally Accepted Accounting Principles earnings
- [ ] Non-Government Accepted Accounting Principles earnings
- [x] Non-Generally Accepted Accounting Principles earnings
- [ ] Non-General Accepted Accounting Principles earnings
## Are Non-GAAP earnings calculated following standard accounting rules?
- [ ] Yes, strictly following GAAP
- [x] No, they are adjusted deviations from GAAP
- [ ] Sometimes, but not often
- [ ] Yes, but only in rare circumstances
## Which of the following is typically excluded from Non-GAAP earnings?
- [ ] Operating income
- [ ] Revenue
- [ ] Cash flow from operations
- [x] One-time expenses, like restructuring costs
## Why might a company report Non-GAAP earnings?
- [ ] To confuse investors
- [ ] Because they provide less meaningful information
- [x] To present financial data that might better reflect ongoing business operations
- [ ] To adhere to regulatory financial disclosures
## Which entity focuses on reviewing GAAP compliance rather than Non-GAAP renditions?
- [x] The Securities and Exchange Commission (SEC)
- [ ] The Internal Revenue Service (IRS)
- [ ] Federal Reserve
- [ ] National Credit Union Administration
## What is a common criticism of Non-GAAP earnings?
- [ ] They provide clear guidelines for accounting
- [ ] Their inclusivity can align performance indicators
- [x] They can be manipulated to present a more favourable view of company's performance
- [ ] They are too rigid and inflexible
## How might analysts view Non-GAAP earnings compared to GAAP earnings?
- [ ] Viewed with more trust and considered more accurate
- [ ] Ignored in favor of GAAP earnings
- [x] Scrutinized alongside GAAP earnings to gain a fuller picture of financial health
- [ ] Automatically preferred to GAAP as more applicable
## What can investors infer from discrepancies between GAAP and Non-GAAP earnings?
- [ ] Little information due to similar methodologies
- [x] Possible manipulations or adjustments by management
- [ ] Directly aligned financial outlooks
- [ ] Consistent business consistency
## In earnings reports, how should Non-GAAP figures be presented according to SEC rules?
- [ ] Presented alone without GAAP measures
- [ ] Prefaced with GAAP measures and reconciliations
- [x] Reconciled with GAAP measures for transparency
- [ ] Mostly inconsistently as per company preference
## When might Non-GAAP earnings align closely with GAAP earnings?
- [ ] In periods of financial instability
- [ ] When a company experiences multiple extraordinary events
- [x] During stable and consistent reporting periods
- [ ] When regulations ready evolve
