GAAP vs non-GAAP

Summary

This video explores the key differences between GAAP (Generally Accepted Accounting Principles) and non-GAAP metrics in financial reporting. It explains how GAAP provides consistency and comparability in financial statements, while non-GAAP metrics offer adjustments to exclude irregular items, potentially providing clearer insights into a company's performance. However, the growing reliance on non-GAAP measures raises concerns about accuracy and potential manipulation. Regulatory bodies are stepping in with guidelines to ensure transparency. The video emphasizes the importance of understanding both GAAP and non-GAAP metrics for informed financial decision-making.

Takeaways

• 😀 GAAP (Generally Accepted Accounting Principles) and non-GAAP metrics are essential concepts in financial reporting that provide different insights into a company's financial performance.
• 😀 GAAP offers uniformity in reporting, enabling comparability between companies and sectors, whereas non-GAAP metrics aim to enrich financial information by excluding certain items.
• 😀 Non-GAAP metrics are often used to adjust for unusual or non-recurring items like severance, pension, and acquisition costs to offer a clearer picture of a company’s ongoing operations.
• 😀 Common non-GAAP metrics include adjusted gross profit, adjusted EBITDA, and adjusted earnings per share, frequently using terms like 'excluding' or 'adjusted'.
• 😀 The use of non-GAAP metrics has grown, and many companies now present both GAAP and non-GAAP figures, making it necessary for investors to understand both perspectives.
• 😀 While non-GAAP measures are not audited, they can present a more favorable financial performance than GAAP figures, raising concerns about potential manipulation.
• 😀 Non-GAAP metrics can be misleading if not presented clearly, which has led to increased regulatory scrutiny from bodies like the SEC and IFRS.
• 😀 In recent years, the SEC and other regulatory bodies have issued guidelines to ensure transparency, including rules about how non-GAAP figures should be presented alongside GAAP figures.
• 😀 One significant concern is that many companies emphasize non-GAAP metrics over GAAP metrics, sometimes overshadowing the GAAP results with better non-GAAP figures.
• 😀 Regulatory steps, including more SEC comment letters and clearer guidance, aim to ensure that non-GAAP figures do not mislead investors and that GAAP remains the primary benchmark in financial reporting.
• 😀 The increasing prominence of GAAP reporting in the S&P 500, as noted in recent analyses, shows that improvements are being made in ensuring transparency and accuracy in financial reports.

Q & A

What does GAAP stand for, and why is it important in financial reporting?

GAAP stands for Generally Accepted Accounting Principles, which are standardized accounting rules used to prepare financial statements. It ensures uniformity and comparability in financial reporting, making it easier for investors and analysts to assess the financial performance of companies.

What is the difference between GAAP and non-GAAP financial metrics?

GAAP metrics follow standardized accounting rules, ensuring consistency and comparability, while non-GAAP metrics are alternative measures of financial performance, often adjusted to exclude certain items like non-recurring charges, to give investors more insight into a company's core operating performance.

Why do companies use non-GAAP metrics in their financial reporting?

Companies use non-GAAP metrics to provide additional insights into their core operating performance by excluding non-recurring or unusual items, such as one-time charges or gains, which can distort the understanding of the company’s true profitability.

Can non-GAAP metrics be misleading to investors?

Yes, non-GAAP metrics can be misleading if they are not presented with appropriate context or if companies selectively exclude certain items in ways that could present a more favorable picture of their financial performance than what GAAP measures show.

What are some common non-GAAP metrics companies use?

Common non-GAAP metrics include adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), adjusted Net Income, adjusted Earnings Per Share (EPS), and Operating Profit excluding special or non-recurring items.

Why do regulators and auditors express concerns about the use of non-GAAP metrics?

Regulators and auditors are concerned that the widespread use of non-GAAP metrics can overshadow GAAP results, potentially misleading investors. Non-GAAP metrics are not audited, and the inconsistency in how they are calculated could lead to biased representations of a company's financial health.

How do regulators like the SEC address concerns regarding non-GAAP metrics?

The SEC has issued guidance to ensure that non-GAAP measures are presented fairly. This includes requirements like presenting the most directly comparable GAAP measure with equal prominence, not emphasizing non-GAAP measures over GAAP, and explaining the rationale behind using non-GAAP metrics.

What are the potential dangers of non-GAAP metrics being used excessively in financial reporting?

Excessive use of non-GAAP metrics could lead to the concept of 'Earnings Before Bad Stuff,' where companies selectively omit unfavorable items, making the company appear more profitable than it truly is. This could mislead investors and create a distorted view of a company's financial performance.

How does non-GAAP reporting affect the comparability of financial data across companies?

Non-GAAP metrics can reduce the comparability of financial data because they are not standardized across companies. Unlike GAAP, which has uniform rules, non-GAAP metrics can vary significantly depending on how each company defines and adjusts their metrics, making it harder to compare companies on a like-for-like basis.

What are some examples of non-GAAP adjustments by specific companies, like Verizon and Valeant?

Verizon provides non-GAAP metrics by excluding significant charges or credits in the 'Severance, Pension, and Benefit' line to give a clearer picture of long-term profitability. Valeant, on the other hand, adjusts its financials by stripping out items like amortization of intangible assets and acquisition costs, which significantly alters its profitability, as seen when it reported a large GAAP loss but a non-GAAP profit.