Non-GAAP: everybody’s doing it so let’s figure out what “it” is

Sep 17, 2018

It’s been telegraphed for a while but earlier this month, the Canadian Securities Administrators (CSA) released new proposed rules on how companies present non-GAAP financial measures to the market.

Non-GAAP measures are used by most public companies to explain their financial health to investors in a way they argue is more reflective of their business. While they vary between sectors, frequently used measures include adjusted earnings, adjusted EBITDA, free cash flow, cash flow per share, pro forma earnings, earnings before non-recurring items and others. In turn, analysts use these metrics to determine their view of the go-forward health of the company.

The challenge is that, unlike financial statements, non-GAAP measures are not audited. Some market observers point out that comparing one company’s non-GAAP measures to another’s in the same sector is like comparing apples to oranges. This becomes problematic if a company is believed to be using non-audited metrics to obfuscate their finances or play down poor performance.

How prevalent is the use of non-GAAP? A 2016 study by Veritas Research showed that the vast majority of TSX60 companies used some of these metrics in their reporting. And the issue is global: nearly 80% of S&P500 and FTSE 100 companies use non-GAAP measures to report their performance.

The CSA proposals are intended to provide issuers with clear and mandatory requirements regarding the disclosure of non-GAAP and other financial measures and prescribes reporting requirements for non-GAAP financial measures; supplementary financial measures; segment measures from the notes to the financial statements; and capital management measures from the notes to the financial statements.

Meanwhile, the Accounting Standards Board has embarked on a project to help establish a framework around financial reporting in Canada, including providing definitions around High Quality Performance Measures and guidance regarding non-GAAP measures.

The ICD has been engaged in the non-GAAP discussion for some time, including in discussions with standards-setters and the auditing profession. We focused on non-GAAP measures in a cross-country town hall series we conducted in 2016 and the conclusion from that exercise was that standards-setters and regulators should focus their attention on non-GAAP measures to increase transparency in our capital markets.

To that end, we welcome the focus on non-GAAP reporting and look forward to participating in the stakeholder comment process, which closes on December 5th.

Source: Director Lens September 17 2018