Tracking and accurately recording earnings is important for any business. Financial reports often contain both quarterly and year-to-date earnings records, as well as year-over-year comparisons to show how the business is performing compared to the same time in the previous year. There are different ways to track and report these earnings.
What Is GAAP?
GAAP stands for "Generally Accepted Accounting Principles" and is the de facto standard for financial reporting in America. Not all businesses use GAAP, however, and understanding the GAAP vs non-GAAP argument can help you decide which reporting style is best for your business.
Companies that release GAAP earnings reports conform with the standards set by the Securities and Exchange Commission as a minimum guideline for financial reporting. Reports and other documentation containing GAAP earnings information are comparable to other companies who also use GAAP reporting, as well as financial reports from state and federal agencies. Essentially, GAAP is a uniform baseline of financial reporting standards. Any GAAP-compliant company can include more information than what is required by GAAP guidelines, but cannot contain less.
Understanding Non-GAAP Practices
If GAAP stands for a uniform reporting guideline, non-GAAP stands for everything that falls outside of that guideline. Non-GAAP earnings reports may not include all of the data required by GAAP standards because not all of that information is useful or relevant to the business that created the report. Non-GAAP reports may exclude certain expenses to provide a clearer picture of day-to-day activities or they may track certain items in ways that fall outside of GAAP standards. There is no one specific practice that is defined as "non-GAAP"; instead, non-GAAP practices are any practice that falls outside of GAAP guidelines. You may also see them referred to as "adjusted earnings," paired with an explanation of how they differ from GAAP earnings to meet SEC reporting requirements.
GAAP vs Non-GAAP
The GAAP vs non-GAAP debate isn't as complex as it may seem at first, but it's still important to understand the differences between the two practices. GAAP is the standard and is designed to provide a clear picture of how a business operates from a financial point of view. Non-GAAP deviates from the standard, making adjustments as needed to convey information that is relevant to the company's operation. Non-GAAP reporting is sometimes frowned upon if it is done without a good reason; some companies have used non-GAAP practices to try and hide problems with their financials or otherwise mislead people looking at their financials. Other companies use non-GAAP reporting because it better fits their business model. This is why the GAAP vs non-GAAP argument is such a hot topic because there are legitimate reasons to use non-GAAP reporting. However, not every company that uses non-GAAP practices has a legitimate reason.
Which Is Right for You?
In general, GAAP earnings reporting is the preferred option because it is based on a specific set of guidelines that are widely used in the business world. GAAP doesn't fit every business model, however, and it's possible that GAAP guidelines may require a business to include information that isn't relevant to its operations. When this happens, non-GAAP reporting is required to paint a better picture of how the company operates and how healthy it is financially. The decision to use GAAP or non-GAAP reporting has to take the company's operations into consideration, but knowing the difference between the two helps to ensure that the company chooses the best option.
- Securities Exchange Commission: Conditions for Use of Non-GAAP Financial Measures
- Echelon: Use of Non-GAAP Financial Information
- Business Insider: Here's How You Should Think About 'Adjusted' Earnings
- Zacks: GAAP vs. Non-GAAP Earnings
- The Motley Fool: Foolish Fundamentals - GAAP
- Harvard Law School: Disclosure of Non-GAAP Financial Measures
- FAF. "About GAAP," Accessed Aug. 4, 2020.
- FAF. "Accounting Standards." Accessed Aug. 4, 2020.
- U.S. Securities & Exchange Commission. "Topic 8 - Non-GAAP Measures of Financial Performance, Liquidity, and Net Worth." Accessed Aug. 4, 2020.
- Audit Analytics. "Long-Term Trends in Non-GAAP Disclosures: A Three-Year Overview," Accessed Aug. 4, 2020.
- U.S. Securities and Exchange Commission. "Cautionary Advice Regarding the Use of "Pro Forma" Financial Information in Earnings Releases," Accessed Aug. 4, 2020.
- IFRS. "CMAC—Call for Members." Accessed Aug. 4, 2020.
- FASB. "For the Investor: The Use of Non-GAAP Metrics," Accessed Aug. 4, 2020.
- McKinsey & Company. "Building a Better Income Statement," Accessed Aug. 4, 2020.
Jack Gerard is a freelance writer and editor with over 15 years of experience writing about topics related to business and finance. His body of work includes copy for small businesses, how-to guides for entrepreneurs and even editing and copy work for international corporations.