GAAP stands for Generally Accepted Accounting Principles, which includes Indian GAAP, Ind AS, IFRS, US GAAP, or any other prescribed accounting framework. GAAP lays down a uniform set of rules and formats, along with guidelines for recognition, measurement, and disclosure that companies need to adopt for accounting and reporting purposes. On the other hand, non-GAAP is a tailored and customized set of performance measures adopted by companies to report their own performance. Non-GAAP measures are not defined by accounting standards.
In recent times, companies have increasingly been using non-GAAP measures in their investor communication and capital markets-related offer documents. The rationale for the use of such non-GAAP measures is that they assist management to provide the users of financial information with an understanding of the key business drivers of the company and enable management to present a perspective to users, which might not be possible only through GAAP measures.
With the increasing use of non-GAAP measures by companies, it is essential to have defined principles that will not only bring parity/consistency amongst companies using non-GAAP measures but will also enable the investors to compare, understand and interpret them meaningfully.
Globally, reporting considerations prescribed by the regulators require management to clearly disclose the purpose and use of non-GAAP measures with a transparent label without having any undue prominence. Regulations also prohibit management from using misleading and individually tailored accounting principles as non-GAAP measures.
In India, the SEBI issued a regulation on KPIs included in Offer Documents in November 2022, which requires companies to provide information on non-GAAP measures and metrics. This has been followed up with the Institute of Chartered Accountants of India (ICAI) issuing a technical guide, in April 2023, on the disclosure and reporting of KPIs in offer documents.
Whilst these provide guidance to the issuer’s management, its Audit Committee, and the statutory auditors / Chartered Accountants associated with the issuer on KPI preparation, reporting, and certification, there is no regulation in the Indian context which governs the use of non-GAAP measures by companies, outside of the offer documents.
An analysis of performance measures presented in investor communications by the top 100 NIFTY companies (based on market capitalisation as of 14 February 2023) for the annual year ended 31 March 2022 and the 3 quarters ended 30 June 2022, 30 September 2022 and 31 December 2022, shows the widespread use of non-GAAP measures across sectors. Out of the 100 companies analysed, 94 have used non-GAAP measures. More particularly, we note that companies in the start-up/IPO stage have utilized non-GAAP measures as a tool, a lot more than traditional companies, in communicating their business performance to investors.
Earnings before interest, taxes, depreciation, and amortization (EBITDA), adjusted EBITDA, adjusted EBITDA margin, adjusted revenue, funds from operations, gross margin, operating profit/ operating income/ operating margin, adjusted profit, contribution margin, and free cash flows are the most common non-GAAP measures reported by companies.
It’s quite interesting to see that the manner of arriving at the non-GAAP measure differs by companies even for the commonly used item. For instance, the adjustments made to GAAP measures, like profit before tax, to compute the non-GAAP measures vary across companies. Further, some companies include other income as part of EBITDA while others do not.
Additionally, the majority of companies also do not disclose a reconciliation of non-GAAP measures to the nearest financial statement item, like reconciliation between EBITDA and profit before tax, which could provide users with an understanding of how the non-GAAP measure is related to or reconciles to a GAAP measure.
Although the regulators and standard setters are making continual progress in requiring companies to explain the use of non-GAAP measures and metrics included in the financial statements/ filings and capital market offering documents as a common practice, it is worth noting that non-GAAP measures are also widely used outside of the financial statements, such as, in investor presentations and analysts’ calls, an area which is currently not covered by any of the existing regulations.
Hence, given the increasing use of non-GAAP measures and metrics becoming an important mechanism for stakeholder engagement, there may be merit in the regulators and standard setters bringing in a potential framework to include such areas within the purview.
Till the time such a framework is in place, from a company’s perspective, some of the specific aspects to consider would be:
• whether the company has a clear policy/ formal process for approving non-GAAP measures used in engagement with external stakeholders.
• whether those charged with governance have duly assessed and concluded that the used non-GAAP measure or metric is relevant, consistently used over periods as well as within the industry sector, and is not misleading in the context of the company’s business.
• do those charged with governance understand and review how the non-GAAP measure reconciles to the nearest GAAP measure; and
• are required internal controls implemented on quantifying and ensuring the accuracy of the non-GAAP measure or metric.
In summary, it is true that, across all industries and sectors, effective use of non-GAAP measures requires stringent regulations and defined principles for stakeholders to rely on non-GAAP measures reported by any company. This also entails investments to be made by the companies in planning, monitoring, and ensuring compliance with the applicable rules and regulations which would allow management to effectively communicate their perspective on their company’s financial position and/or performance and aid in meaningful stakeholder engagement.
(The article is authored by Mr. Sandip Khetan, Co-founder & Global Head of Accounting and Reporting Consulting, Uniqus Consultech, and Mr. Sagar Lakhani, Partner – Accounting and Reporting Consulting, Uniqus)
