For the Investor:
The Use of Non-GAAP Metrics

By Marc Siegel, FASB Member

The continuing proliferation of non-GAAP metrics is a topic that is raised regularly by various members of the financial reporting community.
At first glance it might seem unusual for a column in the FASB Outlook to be discussing accounting metrics that are not Generally Accepted Accounting Principles (GAAP) promulgated by the FASB. But the continuing proliferation of non-GAAP metrics is a topic that is raised regularly by various members of the financial reporting community.

For example, stakeholders often ask the FASB:

Does the prevalence of non-GAAP metrics necessarily dilute financial statement information?

What value do non-GAAP metrics provide to financial statement users and what do they do with them?

Many assert that the use of non-GAAP metrics is increasing. For example, McKinsey & Company states that “many companies – including all of the 25 largest US-based nonfinancial companies—are increasingly reporting some form of non-GAAP earnings.”

But whether they are increasing or not, the reporting of non-GAAP information is far from new. Academics have studied the phenomenon for years.

For example, one study focused on the common exclusion of stock-based compensation in pro-forma earnings. This research concluded that “earnings that include stock-based compensation expense [have] significantly greater predictive ability for future earnings for firms whose pro forma earnings exclude the expense.”

Other research specifically questions whether GAAP-based metrics or nonfinancial measures of performance are more correlated to stock returns. One study in particular looked to analyst reports to ascertain the non-GAAP metrics most acknowledged as essential for valuing companies in particular industries. The study concluded that those non-GAAP metrics were NOT superior to GAAP earnings in explaining stock returns.
The combination of non-GAAP data outside the financial statements with information residing within the audited financial statements is more impactful than either dataset on its own.
This does not mean that the non-GAAP metrics always are uninformative.

In my experience, the combination of non-GAAP data outside the financial statements with information residing within the audited financial statements is more impactful than either dataset on its own. The non-GAAP information in a company’s communications with investors often provides insights into how management views their performance.

For public companies, this information is usually presented in an earnings release and is often coupled with a PowerPoint presentation and conference call to provide financial statement users with a picture of the organization’s financial position and performance.

As an analyst, I attempt to do a thorough review of the financial statements and footnotes to establish whether the picture painted by the audited metrics corresponds with the view from the non-GAAP metrics. The more correlated the GAAP and non-GAAP metrics trends are, the more comfort I feel.

As a result, I find the combination of the two sets of information to be a powerful analytical tool in understanding the underlying business because they complement each other.

Given that management’s view of the business (non-GAAP) and GAAP performance measures are both important, both pieces should evolve over time. While empirical research does not indicate that non-GAAP information points to a fundamental problem with financial accounting recognition and measurement, it is possible that the non-GAAP measures point to a need to consider how similar information might be better organized or presented in the income statement.

Our goal would be to increase the understandability of the performance statement by presenting certain items that may affect the amount, timing, and uncertainty of an organization’s cash flows.
As such, the FASB staff is undertaking research in a project on Financial Performance Reporting.

If this project is officially added to our agenda, we would look to find ways to improve the relevance of information presented in the performance (income) statement for public and private companies. Our goal would be to increase the understandability of the performance statement by presenting certain items that may affect the amount, timing, and uncertainty of an organization’s cash flows. Specifically, the research is developing a framework for defining operating activities and distinguishing between recurring and infrequent items.

Click here for the current status of the project and be on the lookout for more information on it in a future FASB Outlook.