Non-GAAP Metrics

As a CPA who does a lot of financial accounting, I am quite fluent in generally accepted accounting principles (GAAP). For many of the individuals and businesses that I work with, GAAP is used for many of their metrics and reporting. However, there are some key non-GAAP metrics that are commonly used in the business world. Today we're going to dive deeper into a couple of them.

Why Use Non-GAAP Metrics?

GAAP provides a framework that allows for everyone to understand The outputs of a company's financial reports because under GAAP, they are all presented using the same rules. However, certain aspects of GAAP don't capture what certain business owners and investors find important in certain situations. This is where non-GAAP metrics come into play. While you won't be seeing many of these on an audited financial statement, you'd be surprised at how many business owners and investors value these metrics.

EBITDA

EBITDA stands for earnings before interest taxes depreciation and amortization. It represents the earnings of a business before layering on its debt structure, tax structure, and non-cash income statement metrics. You've likely heard of this one because it is fairly commonly used to evaluate the operating effectiveness of a business. When a person or firm is looking to buy another business, this is usually the place where they start looking. 

Management Adjusted EBITDA 

In addition to regular EBITDA, Management Adjusted EBITDA is commonly used in the context of transactions, when businesses are bought and sold. The main difference between regular EBITDA and Management Adjusted EBITDA are (You guessed it!) additional adjustments provided by management for activities that are deemed to be unnecessary or non-recurring. For example, a business that is paying an owner. A very large salary for not doing very much should probably adjust its income statement metrics to reflect a more reasonable level of compensation if they were to replace that owner. Another common adjustment is the use of consultants for transaction advisory services. A buyer and seller can usually agree that the extra money spent on making a transaction happen is not part of the regular operation of a company and should therefore be ignored when considering metrics that reflect the standard operation of the business.

ARR

ARR stands for annual recurring revenue. This metric is commonly used to help value and evaluate the performance of software as a service (SaaS) technology companies. It represents the level of revenue that is coming from customers on a recurring basis, usually tied to a product with some type of subscription. If you've ever wondered why technology companies care so much about their customer or subscriber account, this is it. I've known many tech companies that are bought simply because they have a good idea and a certain number of customers supporting that idea, regardless of how much money the company's actually making. For companies in their early stages, their goal is likely to increase their ARR above everything else, including becoming profitable. It's common for private equity firms to purchase technology companies based on a multiple of their annual recurring revenue, so it's certainly an important metric to track. 

It's important to understand these Non-GAAP Metrics because not everyone cares about the traditional GAAP metrics all the time. As a financial professional, it's important that you understand the many different ways that an owner, investor, or buyer May evaluate or value a business. Depending on which metric is most important, different decisions will be made to drive businesses forward, and it's important that you understand what is driving value in the eyes of the key players in any business decision. Now, get out there and start measuring!