The Pitfalls of Non-GAAP Metrics
Lurking within the financial statements and communications of public companies is a troubling trend. Alternative metrics, once used sparingly, have become increasingly ubiquitous and more detached from reality.
In 2011, Groupon Inc. announced plans for a highly anticipated initial public offering. But enthusiasm for the offering waned when the U.S. Securities and Exchange Commission (SEC) issued a comment letter questioning Groupon’s use of a profit metric it called “adjusted consolidated segment operating income.” To our knowledge, no company had ever used that metric before; it was intended to measure operating profit without including marketing expenses, stock-based compensation, and acquisition-related costs. Management argued that a $420 million loss from operations reported on its 2010 income statement should really be considered a $60 million gain.
For decades, companies have used custom metrics that don’t conform to generally accepted accounting principles (GAAP) or international financial reporting standards (IFRS) as supplements to their official financial statements. (Although we use the term “non-GAAP” throughout this article, the arguments we make here apply equally to companies that report under IFRS and the related disclosure of “non-IFRS measures.”) Some common non-GAAP measures include free cash flow, funds from operations, adjusted revenues, adjusted earnings, adjusted earnings per share, adjusted earnings before interest, taxes, depreciation, and amortization (known as adjusted EBITDA), and net debt.
However, it’s not unusual for the alternative measures to lead to problems. Since companies devise their own methods of calculation, there’s no way to compare the metrics from company to company — or, in many cases, even from year to year within the same company. Lately, in the course of examining the financial statements and communications of thousands of public companies in at least a dozen countries, we have seen a troubling trend. Alternative measures, once used fairly sparingly and shared mostly with a small group of professional investors, have become more ubiquitous and further and further disconnected from reality. (See “About the Research.”)
References (21)
1. A. Jagannath and T. Koller, “Building a Better Income Statement,” November 2013, www.mckinsey.com.
2. “An Alternative Picture of Performance: Alternative Performance Measure Reporting Practices in the FTSE 100,” January 2016, www.pwc.co.uk.
