Four Reasons Non-GAAP Metrics Are Exploding

June 25, 2013, 4:36 PM ET

Four Reasons Non-GAAP Metrics Are Exploding

Emily Chasan

U.S. companies are relying more and more on non-traditional financial reporting metrics to run their companies and communicate with investors.

Since U.S. securities regulators relaxed their stance on the use of non-GAAP measures in 2010, many companies have begun to report metrics like customer churn rates and average revenue per user. Companies can include such metrics in financial reports as long as they aren’t misleading.But the move to include more non-GAAP metrics is also being driven by a need of both investors and corporate managers to focus on measures that have less noise and are clear drivers of the future direction of the business, Professor Paul Bahnson of Boise State University and Professor Paul Miller of University of Colorado at Colorado Springs argued at an Institute of Management Accountants conference in New Orleans this week.

Here are four reasons why the professors said more companies are moving toward taking a Do-It-Yourself approach to financial reporting metrics that are not required by accounting rules:

Disconnect Between Needs of Companies and Investors. “There’s a disconnect between what finance departments want to report and financial statement users want to receive,” Dr. Bahnson said at the conference. Corporate managers may be preferring to report smoother results with less volatility based on readily available historical information, but investors and other financial statement users want to make sure they are seeing more current information and capturing natural volatility that is present in the economics of a business, Dr. Bahnson said.

Historical Cost Information Is Losing Its Relevance. Historical costs “do not provide useful information because they don’t tell you anything about the present,” Dr. Miller said at the conference. While financial reporting has moved more toward real-time measures reported at fair-values over the past decade, investors are still demanding more information about the present values of corporate assets. Dr. Miller urged accountants at the conference to think about historical costs as “unverifiable” and “unreliable” since they are statistically based on a sample size of a single transaction and cannot capture the full market value of an asset.

Some GAAP Metrics Are Particularly Noisy. The process to change accounting rules is political and takes time, so some areas of accounting under Generally Accepted Accounting Principles haven’t been updated in years, such as accounting for research and development or accounting for stock held in the corporate treasury. Accounting metrics may not be that useful internally because accounting rules often rely on underlying assumptions that obscure the incremental cost information managers need to make decisions, Dr. Bahnson said. When accounting rule makers required more present-value ways of accounting for pensions “we saw changes in the way that pension plans are managed,” Dr. Bahnson added. If companies and investors don’t see value in some GAAP metrics, “the solution is to provide more information, better information designed to reduce uncertainty and risk,” Dr. Miller said.

Non-GAAP Metrics May Reduce Cost of Capital. Since investors are seeking more transparency into the business, companies reporting metrics they think give investors a more relevant picture of the business could be reducing their company’s cost of capital. “If you could save yourself a couple basis points on your cost of capital, you could  spend a huge amount of money on financial reporting,” Dr. Bahnson said. Companies could improve their data and metrics if it contributes to reduced cost of capital, he said.