Non-GAAP Financial Measures: What Not to Report: SEC Regulations Prohibit Public Companies in the United States from Publishing Certain Types of Financial Information

By Pounder, Bruce | Strategic Finance, October 2011 | Go to article overview

Non-GAAP Financial Measures: What Not to Report: SEC Regulations Prohibit Public Companies in the United States from Publishing Certain Types of Financial Information


Pounder, Bruce, Strategic Finance


Reporting entities that prepare financial statements in accordance with an authoritative set of financial accounting and reporting standards--such as U.S. Generally Accepted Accounting Principles (GAAP)--often supplement their financial statements with additional information. This practice is especially common in the United States, where public companies routinely report a variety of non-GAAP financial measures to present and prospective investors. But even though the rules of GAAP don't apply to such measures, other rules do. In this month's column, I'll provide examples of non-GAAP financial measures that public U.S. companies report, summarize how the U.S. Securities & Exchange Commission (SEC) regulates the reporting of those measures, and examine a recent case in which a high-profile company overstepped the limits that SEC regulations impose.

Going Beyond GAAP

U.S. GAAP identifies specific measures of financial position, financial performance, and cash flow that reporting entities must or may include in their financial statements. U.S. GAAP also prescribes the manner in which those measures are to be determined and presented. But company executives often make managerial decisions on the basis of financial measures other than those dictated by GAAP. And because investors can benefit from looking at a company "through the eyes of management," they usually expect companies to report the non-GAAP financial measures that managers use in addition to reporting GAAP-compliant measures.

One example of a widely used and reported non-GAAP financial measure is "earnings before interest, taxes, depreciation, and amortization" (EBITDA). Conceptually, EBITDA represents the financial performance of an entity without regard for effects of the entity's financing decisions, exposure to income taxes, and current-period allocations of long-lived asset costs. Many corporate boards of directors consider EBITDA such an important measure of financial performance that they base a significant portion of executive compensation on it.

Some non-GAAP financial measures, such as EBITDA, are used extensively by companies in different industries. But other non-GAAP financial measures are industry-specific. For example, many retailers report "same store sales" (i.e., sales made by companies open for at least a year), a non-GAAP financial measure that has little applicability outside the retail industry.

The use and reporting of a particular non-GAAP financial measure may even be limited to a single company. For example, in its Form 10-Q quarterly report filed with the SEC on November 3, 2009, Martin Marietta Materials, Inc. (NYSE: MLM) reported the highly idiosyncratic non-GAAP measure "Gross margin excluding freight and delivery revenues assuming production costs that cannot be inventoried due to operating below capacity for the quarter ended September 30, 2009 were at the level incurred for the quarter ended September 30, 2008."

The SEC'S Perspective

Although a company's managers can define and use non-GAAP financial measures as they see fit, the SEC is concerned with how its registrants report such measures. For example, SEC Regulation S-K prohibits registrants from presenting non-GAAP financial measures on the face of their financial statements or in the accompanying notes when the statements are filed with the SEC. Regulation S-K also requires filers that report non-GAAP financial measures to provide specific disclosures regarding the measures.

Furthermore, when publicly disclosing material information that includes a non-GAAP financial measure, an SEC registrant must present the non-GAAP financial measure within a prescribed context. Most significantly, SEC Regulation G generally requires each publicly disclosed non-GAAP financial measure to be accompanied by the most directly comparable GAAP financial measure and a reconciliation of the differences between the two. …

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