One of the most comprehensive ways for external parties to get a quick overview into your company‘s current financial state is through financial reports. Through quarterly financial statements—such as income statements or balance sheets—companies can provide a snapshot of their cash flow, operating expenses, and overall financial performance.
Accurate financial information is critical for accountants, shareholders, or investors; this can affect decisions made on corporate matters, future investments, and other factors. With a combination of quantitative data and a holistic understanding of the company, industry, and offerings, it becomes easy to glean powerful insights into the company’s inner workings.
Unfortunately, the world of financial performance reporting has had much lack of standardization in reporting terminology and disclosure interpretations. Both within and across industries, it can be difficult to get a clear understanding of financial performance.
If you’re unable to get a good overview of your company’s financial health, you may have difficulty foreseeing expenses or could operate under an inaccurate budget. This uncertainty can also cause investors to keep away, or mislead them and cause catastrophic consequences down the road.
In short, it’s important to prepare standardized and clear accounting statements—such as by using GAAP—both for your company and external parties.
But what exactly is GAAP and non-GAAP accounting? Which is better for your company? In this article, we’ll break down the differences and similarities between the two accounting measures, explain the importance of revenue recognition, and cover why it matters for your company.
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What is GAAP?
GAAP, or the generally accepted accounting principles, are standardized principles for accounting created by the Financial Accounting Standards Board (FASB) and governed by the U.S. Securities and Exchange Commission (SEC). By providing a standardized set of rules and guidelines around topics such as revenue recognition and disclosure, businesses can more objectively report on their financial health, regardless of their industry.
By using GAAP, it’s easier for investors, creditors, and other stakeholders to compare companies against each other, and verify and trust the results they see. GAAP is the most common set of principles used for financial reporting: all public companies are required to use GAAP. Additionally, state and local governments, some private companies, and many nonprofit organizations use GAAP, as it’s looked upon favorably by creditors and investors.
What is non-GAAP?
If GAAP provides a standardized view of most companies’ financial standing, it begs the question: why use other methods?
Essentially, many organizations find that GAAP accounting doesn’t provide a full overview of their financial health, and use non-GAAP to complement their GAAP financial statements. Non-GAAP measurements aren’t brand-new financial statements; rather, they’re simply adjusted results.
While these standards weren’t created by the FASB, non-GAAP standards are governed by the SEC, and deliberately misleading stakeholders is prohibited. As long as figures are clearly disclosed as non-GAAP, companies can include these financial statements and then reconcile the varying amounts. The most-used type of non-GAAP is EBITDA—or earnings before interest, taxes, and depreciation—and can be used as an alternative to net income.
When used properly, non-GAAP figures may exclude irregular, non-cash, or non-recurring expenses, if companies believe that these amounts are not a true reflection of their overall financial health. For example, let’s say your company undergoes a restructuring with a change of ownership. This could incur significant expenses, but if all signs point towards continued profitability, you could choose to exclude this one-time expense from your balance sheet with non-GAAP reporting.
How are GAAP and non-GAAP similar?
Now that we’ve covered their definitions, let’s look at the overlaps between GAAP and non-GAAP accounting.
They’re both accounting measures.
At the end of the day, both GAAP and non-GAAP are sets of accounting principles to follow. Even if you use non-GAAP measures such as EBITDA or free cash flow, there are prescribed standards you must follow to prepare your financial reporting. Both principles provide a snapshot of your company’s financial health, although both may be necessary for a truly comprehensive overview.
The SEC scrutinizes them both.
Regardless of the standard you use, both accounting principles are governed and regulated by the SEC. Neither public nor private companies can use non-GAAP financials to skirt the law; punitive actions can and have been taken against companies that have tried to use non-GAAP measures to misconstrue their financials.
How are GAAP and non-GAAP different?
While there is some overlap between the two principles, there are several key differences you should be aware of.
Levels of standards.
GAAP is seen as the industry standard across the U.S. Note that it‘s not a worldwide standard, as the International Financial Reporting Standards (IFRS) is used on a global level across over 160 jurisdictions. That said, within the U.S., GAAP is the financial reporting standard, whereas non-GAAP is not.
Who uses what.
All publicly-traded companies are required to use GAAP for accounting. While they can complement it with non-GAAP measures, their financial statements must be in accordance with GAAP. However, private companies are not required to use GAAP financial reports.
Adjusted earnings.
The biggest difference between GAAP and non-GAAP is that non-GAAP figures are not required to include non-recurring or non-cash expenses. Non-recurring expenses are seen as one-time or extraordinary expenses, such as one-off real estate or equipment purchases or costs following an accident.
Non-cash expenses include amortization, depreciation, depletion, or deferred charges. While they are required to be included in GAAP reporting, they don’t affect the cash flow. With non-GAAP reporting, companies can provide adjusted earnings, which may help provide more accurate insights into the operational performance.
Comparability.
While adjusted earnings is the main difference between the two accounting principles, remember that companies using non-GAAP reporting don’t have one single financial measure to adhere to. Because of this, non-GAAP measures makes it more difficult to compare the results of companies both within and between industries.
Reporting on profitability.
It’s commonly agreed that GAAP provides a top-level, overall snapshot of a company’s financial health. GAAP accounting is standardized in line with the 10 key principles such as periodicity, continuity, and non-compensation; however, GAAP accounting may not always provide a full, accurate picture.
In fact, industry data shows that 97% of S&P 500 companies file their statements using at least one non-GAAP measure. This is primarily because GAAP requires certain expenses, such as R&D or branding investments (which are classified as intangible), to be designated as expenses as opposed to assets.
Using non-GAAP numbers allows companies to exclude certain investments and frame them as expenses. Other numbers that can be reported differently using non-GAAP measures include one-time acquisitions costs, stock-based compensation, or even revenue recognition.
In conclusion, there can be many reasons why companies may choose to include non-GAAP earnings when providing financial statements, many of which are fully legitimate. However, it is possible that certain companies may try to use non-GAAP figures to mislead others.
What You Need to Know About GAAP and Revenue Recognition
An important standard particularly for subscription-based companies is revenue recognition. ASC 606, or Accounting Standards Codification as Topic 606: Revenue from Contracts with Customers, has been called the most significant change to accounting standards in the past century. The FASB expects both public and private companies following GAAP to be compliant with ASC 606.
Essentially, ASC 606 requires that income only be recognized as revenue when the customer has received the value from the product or service, essentially creating a difference between earned and deferred revenue.
For example, a CRM SaaS company that charges $299 a month for a service can’t immediately count the full amount as earned revenue. After one week, per ASC 606, the company would only be able to recognize the first week (or the currently delivered portion) as earned revenue, leaving the rest as deferred.
In short, ASC 606 helps provide a clear picture into a company’s financials, especially for subscription-based companies, which tend to have complex revenue streams with new subscriptions, cancellations, upgrades, and downgrades—all of which need to be accurately recognized as revenue.
Wrapping Up
Providing both GAAP and non-GAAP results can offer investors and other stakeholders a more accurate view of your company’s financial health. That said, it‘s always a good idea to keep track of why certain figures may have been excluded and reconcile the numbers before publishing your quarterly statements.
Using a revenue recognition platform helps provide a single source of truth for increased business intelligence when it comes to revenue or cash flow predictions, especially for companies dealing with more complex contract modifications.
That’s why using our all-in-one subscription and billing platform, Stax Bill, is the best choice for ensuring compliance with GAAP principles like ASC 606.
Stax Bill is the only platform on the market that doesn‘t require extra software to ensure full compliance with ASC 606. With full integration for all major ERP solutions, a fully automated back-end process for self-service customer changes, and flexible and scalable data models, implementing a single source of truth for revenue recognition is easy with Stax Bill. It’s that easy.
Stax Bill is a comprehensive subscription and billing platform that simplifies the billing and invoice process for businesses of all sizes. We offer scalable and flexible billing solutions for each business, all with transparent pricing.
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