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Differences and Similarities Between GAAP vs Non-GAAP

GAAP vs Non-GAAP - Compared & Examined
Lauren Ward
Lauren WardUpdated April 26, 2022
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GAAP and non-GAAP are two different accounting methods used by companies to show their financial performance during a certain reporting period. While GAAP follows a very specific set of standards, non-GAAP does not, which is why the revenue each one show’s can be very different. In some cases, GAAP can understate profits. However, non-GAAP numbers can also sometimes be misleading. Read on to learn the differences between GAAP vs non-GAAP,  pros and cons of non-GAAP accounting, and why you would want to use one method over the other.

What is GAAP?

GAAP, which stands for Generally Accepted Accounting Principles, is a set of standards that businesses must follow if they are publicly traded. Governed by the U.S. Securities and Exchange Commission (SEC) and administered by the Financial Accounting Standards Board (FASB), GAAP establishes transparency for publicly traded companies and makes it so one GAAP-compliant company is comparable to another GAAP-compliant company regardless of industry. Private companies that have audited financials also use GAAP when managing their business financesGAAP dictates how a company can recognize revenue and expenses, what types of expenses have to be capitalized as assets, and how information needs to be presented to shareholders in an audited report.GAAP has 10 fundamental principles companies must follow. They are:
  1. Regularity: Accountants agree to use GAAP as a standard. 
  2. Consistency: Accountants must use the same methods and standards throughout the entire reporting process, and continue to use them from one reporting period to the next. If any changes are made, the accountant must fully document and explain why those changes occurred.
  3. Sincerity: All accountants must create a complete and factually accurate report of a company’s financial situation.  
  4. Permanence of methods: All GAAP-compliant companies must be consistent with their methods and reporting. By doing so, all GAAP-compliant companies are able to be compared regardless of their industry. 
  5. Non-compensation: All positive and negative aspects of a company’s performance must be reported without compensating an asset’s debt.
  6. Prudence: No accountant should speculate or give his or her opinion in a financial report. All records must be factually accurate. 
  7. Continuity: It is assumed the company will continue to exist and operate in the foreseeable future. No asset valuations should be tainted with the knowledge the company is going to fail. 
  8. Periodicity: All financial reporting is to take place in established accounting periods (meaning quarterly or annually). 
  9. Materiality: All financial reports should clearly display a company’s financial position. 
  10. Utmost good faith: All parties that contribute to a company’s financial report are assumed to be honest and reputable. 
While small businesses that don’t get audited aren’t required to use GAAP, doing so can be useful in certain situations, such as when they are applying for small business loans. Many lenders and creditors often prefer GAAP-compliant documents or require annual financial statements that follow these principles when they issue loans.

Example

GAAP rules and procedures are used when corporate accountants present the details of a company's financial operations in quarterly balance sheets or income statements, 10-Q filings, and annual reports.

What is Non-GAAP?

While GAAP standardizes financial reporting and makes it easier for investors and creditors to analyze and compare companies, this accounting method has some limitations. Indeed, in some instances, GAAP reporting may not accurately portray the current standing or future financial prospects of a company. When that happens, companies are allowed to display their own accounting figures, as long as they are disclosed as “non-GAAP.” They must also provide a reconciliation between the adjusted (non-GAAP) results and regular (GAAP) results.Non-GAAP figures usually exclude irregular and non-cash expenses, such as those related to acquisitions, restructuring, or one-time balance sheet adjustments. This smooths out swings in earnings that can result from temporary conditions, and can often provide a clearer picture of the ongoing business.However, because non-GAAP figures are developed by the company itself (rather than an independent third party), they may be skewed to the firm’s benefit. Less profitable companies using non-GAAP could mislead the public by a significant margin if they don’t also release GAAP numbers.While the FASB doesn’t create non-GAAP standards, these numbers are still governed by the SEC. In fact, the SEC has taken action against companies it believed were being too aggressive with non-GAAP numbers.

Example

One of the most common forms of non-GAAP measurements in accounting is EBITDA, or earnings before interest, taxes, depreciation, and amortization. By eliminating interest on debt and non-cash expenses like depreciation, EBITDA can be a better reflection of a company’s profits and operational efficiency than net income, which is part of GAAP.  It can also be useful for comparing income from year to year within the same company.

Comparing GAAP vs Non-GAAP

Similarities

Both GAAP and non-GAAP are accounting methods used by companies to show their financial performance during a certain reporting period. Both systems address:

Differences

The key difference between GAAP and non-GAAP is that GAAP follows a set of standards and formats in accounting, while NON-GAAP does not. All public companies need to follow GAAP reporting, whereas private companies have the option of following GAAP or non-GAAP.In addition, GAAP includes non-recurring expenses (such as restructuring costs, acquisitions, and litigation) and interest on company debt, while non-GAAP accounting does not. As a result, non-GAAP can sometimes give a clearer picture of a company’s actual operational efficiency. However, due to lack of standardization, non-GAAP reporting may be used by a company to make it appear more profitable than it really is. Non-GAAP accounting also makes it difficult to compare financial results between companies in an industry and between industries.

Pros and Cons of Non-GAAP

How Prevalent is Non-GAAP Use?

Non-GAAP use has grown significantly in recent years. The majority of companies in the Dow Jones Industrial Average now report non-GAAP earnings per share (EPS) along with GAAP EPS, with the former typically coming in higher than the latter. Technology companies have been major users of non-GAAP reporting, since these companies typically don't report high net income with GAAP.There are companies that use non-GAAP legitimately. They really do have one-time expenses or they have a business model that doesn't lend itself to GAAP reporting. However, the risk of eliminating non-recurring expenses from accounting is that many companies don’t know whether certain “one-time” expenses are actually going to be non-recurring. Not disclosing those costs may, in some situations, mislead investors. 

The Takeaway

Generally Accepted Accounting Principles, or GAAP, is the prescribed standard public companies follow when disclosing financial information. However, GAAP does not suit every company. Many businesses feel that some costs (such as interest on business loans, non-cash expenses like amortization and depreciation, and one-time expenses like litigation) should not influence its net revenue, especially if it makes the company seem as if it experienced a loss when it didn’t. However, due to lack of standardization, non-GAAP accounting can also be misleading.For small business accounting, you don’t have to follow GAAP regulations. However, doing so can make it easier for outsiders to evaluate your business and compare it to other companies in your industry. Publishing non-GAAP, along with GAAP, could make it easier to attract an investor or get approved for certain types of business loans.

3 Small Business Loan Tips

  1. Generally, it can be easier for entrepreneurs starting out to qualify for a loan from an online lender than from a traditional lender. Lantern by SoFi’s single application makes it easy to find and compare small business loan offers from multiple lenders.
  2. Traditionally, lenders like to see a business that’s at least two years old when considering a small business loan.
  3. SBA loans are guaranteed by the U.S. Small Business Administration and typically offer favorable terms. They can also have more complicated applications and requirements than non-SBA business loans.

Photo credit: iStock/AndreyPopov
The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.SOLC0222021

Frequently Asked Questions

Why do companies use non-GAAP?
Are non-GAAP measures audited?
Are non-GAAP and IFRS the same?

About the Author

Lauren Ward

Lauren Ward

Lauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.
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