Non-GAAP Earnings

Article byKhalid Ahmed
Edited byAlfina
Reviewed byDheeraj Vaidya, CFA, FRM

What Are Non-GAAP Earnings?

Non-GAAP earnings refer to those one-time profits or costs of a company that are not required to be disclosed as they lack a standardized calculation method (Generally Accepted Accounting Principles). It facilitates a company in evaluating and displaying its operational performance without accounting for financial or accounting decisions or tax environments to investors.

Non-GAAP Earnings Meaning

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For eg:
Source: Non-GAAP Earnings (wallstreetmojo.com)

Almost 90% of firms under the S&P 500 use it to show their performance accurately to investors. Another example is earnings before interest, tax, depreciation, and amortization (EBITDA). The U.S. Securities and Exchange Commission (SEC) allows the usage of non-GAAP measures but requires companies to match the GAAP standards in calculations.

Key Takeaways

  • Non-GAAP earnings are one-time event transactions or non-recurring events for a company that cannot get reported in GAAP format.
  • It helps a company to highlight its performance to investors by disclosing one-time events or transactions in the quarterly statements.
  • Companies utilize many measures to report on this format, like EBIT, EBITDA, adjusted EBITDA, free cash flow, operating earnings per share, and operating income.  
  • It gives the company an in-depth view of its management and gets criticized for misleading investors by manipulating EBITDA figures to turn losses into profits.

Non-GAAP Earnings Explained

Non-GAAP earnings get deployed for reporting any measures or profits not to be disclosed publicly without using GAAP standards. Sometimes, companies report these and company filings with SEC to build investor confidence and make proper internal management decisions. In addition, companies often use non-GAAP earnings to show their core operations to investors.

For example, in recent times, companies have disproportionately seen an increase in non-recurring transactions. As a result, a few non-GAAP earnings calculations have become an integral part of real estate as funds from operation (FFO)

Many firms deliberately report non-GAAP net income to excite investors and attract more investment. Likewise, companies get to show their net income in a positive light. Firms do these by removing those non-recurring charges and other data that may put their performance in a bad light. The non-GAAP net earnings method most firms use involves transferring certain items from GAAP reporting to earnings of non-GAAP. They are as follows:

All the above items are non-recurring in most cases. However, when these items are excluded from GAAP earnings, they highlight those data that may help others know that the firm is going in the right direction.

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Measures

Various measures get undertaken by companies for reporting non-GAAP measures, as listed below:

  1. EBITEBIT denotes the earnings before interest and tax of a company.
  2. EBITDA- It denotes earnings before interest, tax depreciation, and amortization of a company.
  3. Adjusted EBITDA – It denotes EBITDA, excluding a company’s stock-based compensation cost and past non-cash acquisition charges.
  4. Free cash flowFree cash flow denotes the cash flow obtained after the deduction of reinvestment from a sum of capital expenditure and a company’s working capital.
  5. Operating earnings per share- It denotes the division of operating income by the value of a company’s outstanding shares during a certain timeframe. Thus, it offers investors an excellent overview of a company’s current earnings.
  6. Operating income – It denotes the income obtained after one deducts the sum of recurring revenues and expenses from the combined core operations earnings related to a company.

Significance

The significance of using non-GAAP earnings is as follows:

  • First, it provides an appropriate context for the operations of a company. It gives an important insight into the internal management of a company. 
  • Non-GAAP earnings also give a better understanding of company cash flow.
  • In addition, it helps the company report one-time transactions easily.
  • Excluding non-recurring items from GAAP, like non-cash expenditures, smoothens a company’s financial reporting.
  • They get issued in the form of quarterly statements besides GAAP disclosures.
  • Finally, it completes the information about a company not shown in GAAP disclosure to the investors and other interested parties.

Criticism

The non-GAAP method has certain criticism associated with it. They are:

  • The items listed in non-GAAP net earnings differ every quarter for every company. This happens because companies can add or remove any item in the non-GAAP earnings. Thus, it makes it difficult for analysts and investors to ascertain the real progress, actual profit, and true picture of the financial results of such companies. Hence, it gets highly criticized by the market.
  • The non-GAAP earnings become unreliable for predicting a company’s real growth, including profit and loss. Thus, it makes it difficult for everyone to trust the company’s profile.
  • Another criticism comes from the fact that firms heavily laden with debt or frequent, costly equipment upgrades could misuse the method to their advantage. It may also allow companies with low net income to mask their losses as profit to the investors and general market. As a result, EBITDA gets made at a higher value than the actual recorded net income for such companies.
  • Finally, the investors may get a false picture and may decide to invest in such a company only to realize that they got misled by the investment into a company on losses.

GAAP Earnings Vs Non-GAAP Earnings

Let us look at the differences between the standardized reporting method of GAAP and non-GAAP earnings:

GAAP EarningsNon-GAAP Earnings
Uses the universal method of financial reporting approved by the SEC.It is an informal method of calculating the earnings of a company.
The most trusted form of reporting gives an accurate picture of the health of a company.It can get manipulated to show losses as profits.
Investors use it to make proper investment decisions in a company.Not a good tool to use while making investment decisions.
All publicly listed companies must report their financials in this format.Privately held companies use it along with GAAP format to report their financials.
Gets regulated by the SEC. It does not get regulated by any government or federal authority.
Gives a picture of how a company is performing in its business.Clarifies other operational aspects of a company.
It cannot get manipulated to attract investors.It helps to lure investors into investing in a firm.

Frequently Asked Questions (FAQs)

What are non-GAAP earnings per share?

All those incomes that do not require public disclosure and external reporting mandated by SEC get prepared under the non-GAAP method and get called non-GAAP income. Non-GAAP EPS is calculated by subtracting the non-GAAP income taxes from the net income. This result is then divided by the outstanding diluted share.

How are non-GAAP earnings calculated?

Non-GAAP earnings are a type of accounting method used to calculate a company’s earnings. Non-GAAP earnings like EBITDA get calculated by taking the sum of non-cash expenses related to amortization plus depreciation to add to a company’s operating income.

Why do many companies provide non-GAAP earnings figures?

Many companies provide non-GAAP earnings figures in their reporting because one-time earnings or one-time costs like asset restructuring, asset write-offs, or organizational restructuring do not get a proper place for reporting in GAAP format. Moreover, without non-GAAP measures, a company cannot display its performance to the world.

This article has been a guide to what are Non-GAAP Earnings. Here, we explain its measures, significance, criticism, and comparison with GAAP earnings. You may also find some useful articles here –

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