GAAP vs. Non-GAAP Earnings Explained for Investors

GAAP earnings are profits calculated under Generally Accepted Accounting Principles, the rules that U.S. public companies follow in their audited financial statements. Non-GAAP earnings are figures a company calculates by its own method, usually by adding back or removing certain costs. Most large companies report both, and understanding the gap between the two is one of the most useful skills for reading an earnings report.

In brief

• GAAP is the standardized rulebook. In the United States, the Financial Accounting Standards Board (FASB) sets it, and the SEC oversees its use by public companies.
• Non-GAAP measures are company-defined. Common examples are adjusted EPS, adjusted EBITDA and free cash flow.
• SEC rules require that a non-GAAP measure be reconciled to the most directly comparable GAAP measure.
• Adjustments can be legitimate, but the SEC staff has cautioned against ones that are misleading.
• The reconciliation table in the earnings release is the place to see what was changed.

What GAAP is

GAAP is a body of standards covering how revenue is recognized, how assets are valued, how leases and debt are treated, and what must be disclosed. The FASB maintains the standards, and the SEC has authority over the financial reporting of companies that sell securities to the public. Annual financial statements in a Form 10-K are audited by an independent registered public accounting firm against these standards.

The point of GAAP is comparability. Two companies following the same rules should produce statements that can be read side by side. The cost is that GAAP results include items some managers and analysts regard as noise, such as the effects of an acquisition, a one-time legal settlement or a non-cash charge.

What non-GAAP means

A non-GAAP financial measure, as defined in SEC rules, is a numerical measure of historical or future financial performance, financial position or cash flows that excludes or includes amounts that would not be excluded or included in the most directly comparable GAAP measure. In plain terms, it is any custom profit or cash figure.

Common examples include:

• Adjusted net income and adjusted EPS. GAAP results with selected costs added back.
• EBITDA and adjusted EBITDA. Earnings before interest, taxes, depreciation and amortization, with further company-specific adjustments in the adjusted version.
• Free cash flow. Typically cash from operations less capital expenditures, though definitions vary.
• Operating metrics. Items such as annual recurring revenue or same-store sales are often called key metrics rather than non-GAAP measures, but similar scrutiny applies when they are used to describe performance.

There is no official definition of adjusted EBITDA or free cash flow in GAAP. Two companies using the same label may calculate it differently.

Why companies report both

Management teams say non-GAAP measures show underlying operations by removing items they view as unrelated to the core business. Analysts often build their forecasts on those measures, so companies report them to be compared on the same basis. Non-GAAP figures are also commonly used in internal planning and in executive pay targets.

Critics note that the adjustments are chosen by management and tend to make results look better. Neither view is wrong in every case. The practical approach is to treat non-GAAP measures as information, with GAAP as the anchor.

What the SEC requires

Two pieces of the SEC’s framework apply to non-GAAP measures in public disclosures.

Regulation G applies whenever a registrant publicly discloses a non-GAAP measure, including in an earnings press release. It requires the company to present the most directly comparable GAAP measure and a quantitative reconciliation of the two. The text is in 17 CFR Part 244 on the eCFR.

Item 10(e) of Regulation S-K applies to filings with the SEC, such as the Form 10-K and Form 10-Q. It adds further conditions, including that the GAAP measure be presented with equal or greater prominence than the non-GAAP one. The rules also limit certain practices, for example describing an item as non-recurring when it is reasonably likely to recur or has occurred in recent periods (the rule sets a specific look-back and look-forward window, which readers should confirm in the text). The SEC staff’s Compliance and Disclosure Interpretations on non-GAAP measures give the staff’s views on how the rules apply, including on what the staff considers misleading.

For earnings releases, companies commonly furnish the press release on Form 8-K, and the rules on non-GAAP measures apply to that material as well.

Adjustments that deserve scrutiny

Each adjustment can be tested with simple questions.

1. Does it recur? A “restructuring charge” in every quarter is a cost of doing business in practice.
2. Is it a real cost? Stock-based compensation is non-cash but dilutes owners. Excluding it is common and also debated.
3. Is it a normal operating expense? The SEC staff has said that excluding normal, recurring, cash operating expenses needed to operate the business can be misleading.
4. Is the definition consistent? A change in how the adjusted measure is calculated should be disclosed and explained.
5. Are gains treated like losses? If costs are removed but one-time gains stay in, the adjusted figure is tilted.
6. Is the tax effect shown? Adjusted EPS needs a tax treatment for each item, and the release should disclose it.

The SEC staff has also said that a non-GAAP measure can be misleading if it uses individually tailored accounting principles, for example changing how revenue is recognized in the adjusted figure so that it departs from GAAP.

A worked example (hypothetical)

Take an invented company, Example Corp. Its release shows these figures for a quarter:

Item	Amount (millions of dollars)
GAAP net income	40
Add: stock-based compensation	25
Add: amortization of acquired intangibles	10
Add: restructuring charge	8
Less: tax effect of adjustments	(9)
Non-GAAP net income	74

The adjusted figure is 85% higher than the GAAP one. The reconciliation shows that stock-based compensation is the largest adjustment, which is a real economic cost even though it is not cash. The restructuring charge deserves a check of earlier quarters. The amortization is a non-cash result of past acquisitions, though the acquisitions were paid for in the past. A reader can form a view on each item without calling the adjusted figure wrong. The numbers above are for illustration only.

Common misconceptions

• “Non-GAAP means improper.” Non-GAAP measures are allowed when properly presented and reconciled.
• “GAAP shows everything accurately.” GAAP involves estimates, such as useful lives of assets and reserve levels, that management sets within the rules.
• “Adjusted EBITDA is cash profit.” It ignores capital spending, working capital changes, interest and taxes.
• “The SEC approves non-GAAP numbers.” The SEC sets disclosure rules and its staff can comment on filings, but it does not approve a company’s adjusted figures in advance.
• “All adjustments are the same.” An exclusion of a one-time legal settlement differs from an exclusion of recurring marketing costs.

How to use this when reading results

1. Find the reconciliation table in the release.
2. Read the line items from largest to smallest.
3. Compare the GAAP and non-GAAP trends across several quarters. If GAAP stagnates while adjusted figures climb, find which adjustment is growing.
4. Check cash flow for confirmation.

Our guide on how to read an earnings release places this step in the broader sequence, and our explainer on EPS beats and misses covers how adjusted figures feed headline comparisons.

Key terms

• Reconciliation. A table that starts with the GAAP figure and lists each adjustment leading to the non-GAAP figure.
• Equal or greater prominence. The SEC standard that the GAAP measure must be at least as prominent as the non-GAAP one in a filing or release.
• Non-recurring, infrequent or unusual. Labels companies attach to adjustments. Their use is limited by SEC rules and staff views.
• Stock-based compensation. Equity awards to employees, recorded as an expense under GAAP and often added back in adjusted figures.
• Amortization of intangibles. The gradual expensing of acquired assets such as customer relationships and technology.
• Impairment. A write-down of an asset whose value has fallen below its carrying amount.

Checklist for comparing a GAAP and a non-GAAP result

1. Confirm the GAAP figure appears first or with equal weight.
2. List the three largest adjustments and note whether they are cash or non-cash.
3. Compare the same adjustments with the prior four quarters.
4. Check whether the company defines the measure the same way as last year.
5. Look at cash flow from operations to see whether cash supports the adjusted profit.

FAQ

Is GAAP earnings the same as net income?

GAAP net income is the bottom-line profit under GAAP. GAAP EPS divides that figure, after preferred dividends, by the weighted average shares outstanding.

Are non-GAAP numbers audited?

Generally no. The audit covers the GAAP financial statements. Non-GAAP reconciliations are the company’s own presentation, although they are subject to SEC rules and staff comment.

Why does adjusted EPS usually exceed GAAP EPS?

Because most adjustments add back costs. The reverse can happen when a company removes a large one-time gain.

Can a company report only non-GAAP figures?

Not under the SEC’s rules. It must present the comparable GAAP measure and reconcile the two.

Do other countries use GAAP?

U.S. GAAP applies to U.S. domestic registrants. Many other countries use International Financial Reporting Standards, and foreign private issuers may file under IFRS as issued by the International Accounting Standards Board.