Non-GAAP financial measures: Overview, definition, and example
What are non-GAAP financial measures?
Non-GAAP (Generally Accepted Accounting Principles) financial measures refer to financial metrics or figures that do not adhere to the standard accounting principles set forth by GAAP. These measures are often used by companies to provide a more accurate or insightful view of their financial performance, removing certain items or adjusting for factors that the company believes distort its underlying business results. Non-GAAP measures may include adjustments for one-time expenses, restructuring costs, stock-based compensation, or other items that a company deems as non-recurring or not reflective of its core operating performance.
For example, a company might report its "adjusted EBITDA" (Earnings Before Interest, Taxes, Depreciation, and Amortization), which excludes certain non-recurring expenses to provide a clearer picture of ongoing profitability.
Why are non-GAAP financial measures important?
Non-GAAP financial measures are important because they allow companies to present their financial results in a way that reflects their ongoing operational performance, often by excluding items that could skew the results. By adjusting for one-time events or extraordinary items, companies can provide a clearer picture of their profitability, cash flow, or other key financial metrics that are relevant to investors or analysts. These measures can be particularly useful for businesses that experience fluctuations in certain costs or events that are not indicative of their regular operations.
For investors, non-GAAP measures provide additional transparency and context to a company’s financial health. They help investors understand the impact of exceptional or one-off events and focus on the metrics that are most relevant for decision-making.
Understanding non-GAAP financial measures through an example
Imagine a company that has recently undergone a large restructuring, incurring significant costs such as layoffs, severance packages, and operational shutdowns. While these costs are necessary for the company’s long-term restructuring, they are not expected to recur regularly. To provide a more accurate picture of its ongoing profitability, the company reports a non-GAAP measure called "adjusted operating income," which excludes the restructuring costs. This adjustment helps investors focus on the company’s performance without the impact of the exceptional, non-recurring expenses.
In another example, a tech company may report "adjusted earnings per share" (EPS), which excludes the effect of stock-based compensation costs, which it believes do not accurately reflect its ongoing operating performance. This non-GAAP measure provides investors with a clearer idea of the company’s profitability excluding stock-based compensation.
An example of a non-GAAP financial measures clause
Here’s how a non-GAAP financial measure might appear in a financial statement or earnings release:
“The Company reports Adjusted EBITDA, which excludes certain non-recurring items such as restructuring charges, stock-based compensation, and other one-time expenses. The Company believes that this non-GAAP financial measure provides investors with additional insight into its operational performance and is a useful tool for assessing the Company’s ability to generate cash flow from operations.”
Conclusion
Non-GAAP financial measures are tools used by companies to present financial results in a way that may better reflect their core operational performance by excluding one-time or non-recurring items. These measures provide investors and analysts with additional context, helping them make more informed decisions by focusing on the ongoing and sustainable aspects of the business. While useful, it is important for investors to consider non-GAAP measures alongside GAAP figures to ensure a comprehensive understanding of the company’s financial health.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.