EXISTING GLOBAL AND LOCAL PRACTICES ON MONITORING OF NON-GAAP MEASURES
GAAP stands for Generally Accepted Accounting Principles, which may include 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 disclosures, 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.
Global practice
Globally, regulators have prescribed requirements and prohibitions for use of non- GAAP measures. Some of the salient requirements of such regulators
are as follows:
- Undue prominence should not be placed on non-GAAP measures;
- Purpose and use of the non-GAAP measure should be clearly disclosed i.e. the usefulness of the non-GAAP measure to investors and the additional purpose, if any, for which management uses the non-GAAP measure should be clearly disclosed;
- Non-GAAP measures and related adjustments should be clearly and transparently labelled as such;
- Non-GAAP measures should not be misleading. Some examples where non-GAAP measures could be misleading is if they exclude normal or recurring cash operating expenses necessary for business operations, inconsistent presentation of non-GAAP measures between periods, exclusion of certain non-recurring charges but not of non-recurring gains or are based on individually tailored accounting principles; and
- There should be appropriate disclosure controls and procedures related to disclosure of non-GAAP measures.
Hence, it is essential to have defined principles for frequently used non-GAAP measures which will not only bring parity/consistency amongst companies but will also enable the investors to compare, understand and interpret them meaningfully.
Indian scenario
In India, the SEBI has issued 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 disclosure and reporting of KPIs in Offer Documents.
As per the technical guide, the Issuer company and the lead merchant bankers are primarily responsible to ensure disclosure of KPIs in Offer Documents is in accordance with SEBI regulations. Further, KPIs disclosed in the Offer Document need to be approved by the audit committee of the Issuer company. KPIs disclosed in the offer document are required to be certified by the statutory auditor(s) or chartered accountants or firm of chartered accountants.
Whilst this is a positive move which will significantly enhance transparency and aid investors in decision making in the Indian context, basis our assessment of the filings which have taken place from 21 November 2022 till 15 March 2023, we noted that there was mixed compliance with the SEBI requirements on KPIs (see UNIQUS Corner – Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2022 issued by Uniqus on 3 April 2023).
Further, whilst the SEBI and ICAI guidance provide a framework to the Issuer’s management, its Audit Committee and the statutory auditors / Chartered Accountants associated with the Issuer on KPI preparation, reporting and certification, one may need to assess the incentives required to ensure absolute compliance with the issued regulation.
ANALYSIS OF FILINGS BY INDIAN COMPANIES
We have analysed the non-GAAP disclosures of the top 100 NIFTY companies based on market capitalisation as of 14 February 2023, for the annual year ended 31 March 2022 and the quarters ended 30 June 2022, 30 September 2022 and 31 December 2022, in their investor communications.
FINDINGS
Use of non-GAAP measures
We noted a widespread use ofnon-GAAP measures and that the same is across sectors. As the data below indicates, 94 of the 100 companies 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.
Nature of non-GAAP measures used by companies
Frequently used non-GAAP financial measures
- Earnings before interest, taxes, depreciation, and amortization (EBITDA)
- Adjusted EBITDA
- Adjusted EBITDA Margin
- Adjusted Revenue
- Funds from operations
Other non-GAAP financial measures
- Gross Margin
- Operating Profit/ Operating Income/ Operating Margin
- Adjusted Profit Contribution Margin Free Cash flows
Manner of determining non-GAAP measures
Within the non-GAAP measures, we noted that the manner of arriving at a non- GAAP measure differs by companies. For example, the adjustments made to GAAP measures, like profit before tax, to compute the non-GAAP measures varies across the companies, for instance, some companies have included other income as part of EBITDA while others have not. Further, companies have also adjusted GAAP measures to exclude, for example, non-operating gains and losses, restructuring charges, integration costs, stock compensation costs, impairment charges or gains and losses from asset dispositions in reporting financial results.
Reconciliation to GAAP measures
We also noted that majority of companies do not disclose reconciliation of non- GAAP measures to the nearest financial statement item, for example reconciliation between EBITDA and profit before tax, which would otherwise provide users with an understanding of how the non-GAAP measure is related to or reconciles to a GAAP measure.
AREAS WHICH COULD BENEFIT FROM ADDITIONAL GUIDANCE / REGULATION / OVERSIGHT OF MANAGEMENT
We note that the regulators and standard setters are making continual progress on requiring companies to explain the non-GAAP measures and metrics included in the financial statements / filings and capital market offering documents.
However, as a common practice, it is noted that non-GAAP measures and metrics are also widely used outside of the financial statements, for example, in investor presentations and analysts calls, an area which is currently not covered by the existing regulations. Considering that the use of non-GAAP measures and metrics is increasingly becoming an important mechanism for stakeholder engagement, there may be merit in the regulators and standard setters thinking about the potential framework to include such areas within its purview.
CONCLUSION
Although GAAP measures are the prescribed standard to be followed in reporting to users, it may not be suitable for every company and its users. Hence, some adjustments may be required to be made to the GAAP measures to make it suitable to users, so as to enable the reporting company to effectively present its business results and performance.
From an investor perspective, prescribed standards and formats are required so as to rely on non-GAAP measure as part of reporting by any company. Until such measures are stringently applied in practice, companies should follow GAAP reporting in their accounting and reporting.
In conclusion, across all industries and sectors, it is true that effective use of non- GAAP measures requires careful, up-front, and thoughtful planning. This requires an investment to be made by the companies. However, that investment and compliance with the applicable rules and regulations, can allow management to effectively communicate their perspective on their company’s financial position and/or performance and aid in meaningful stakeholder engagement.
