Accounting 300 words. 3hrs

8

Non-GAAPs Measures

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Introduction/Purpose

Accounting and finance profession requires that the process or recording transaction and preparation of the financial statements be done with some standards that are generally outlined as GAAPs. The standards enables organizations, companies whether private or public and other institutions to be accurate and transparent in their preparation and recording of financial statements. In order to achieve transparency, accuracy and consistency in the predation of financial reports, GAAPs is used as the standard measure. GAAPs stand for generally accepted accounting principles. There is no universal standard that applies to all organizations in different geographical locations in the world. These standards normally differ from one country to the other. Generally accepted accounting principle is the bedrock for understanding of their financial performance of an institution whether public or private owned. GAAPs normally outlines the procedures and the scorecard for the preparation of financial reports and statements therefore when a particular company prepares its financial statements without employing the methodology outlined in GAAPs, then such a company is said to be using a Non-GAAP measure. Non-GAAP measure does not apply the standards stated as the generally accepted accounting principles. Non-GAAPs tries to explain the historical financial performance of a company and the projected and expected future performance of a particular company, the current financial position and the general cash flows.

A number of Non-GAAP measures that will be discussed herein include but not limited to EBITDA (Earnings before Interest and Tax, Depreciation and Amortization), Adjusted Earning, funds from operation (FFO), other cash earning (CE), free cash flows (FCF) and EBIT (Earnings before Interest and Tax). Other Non-GAAP measures include Net Operating Income (NOI), modified funds from operations (MFFO), Broad cash flow (BCF) and ROIC (Return on invested capital). Each of these non-GAAP measures have been explained below.

Earnings before Interest, Tax, Depreciation and Amortization is a type of Non-GAAP measure to determine the general operating performance of a company. Some of the merits of EBITDA include its ability to compare competitive firms in terms of their performance, it indicates a company’s efficiency and effectiveness regarding financial performance, gives the general outlook of business performance. EBITDA does not consider capital investments and other financial variables that may affect the financial position of the company. It only include expenses that are considered necessary in the day’s operation of the company. EBITDA gives an account of cash flows that might have been generated by the ongoing operations in the company. Some of the disadvantages of earnings before interest tax, depreciation and amortization include its failure to include capital expenditure in its calculations, it does not account for any changes in the cost of working capital, it does not give an insight of tax implications on the firm, it does not account for the effect of tax and its related computations and how it affects the health of any business. Besides, it does not explain the process of converting the most liquid assets into cash and other forms of cash equivalents and it also fails to account for the effect of depreciation on the profit projects of a firm.

Adjusted Earnings refers to the earnings that a company makes in relation to the share prices of the common stocks of the company. Such earnings are also adjusted depending on the company’s expenses on research and development in order to improve its market share. It can be used for evaluating the performance of a company and it allows easier comparisons to be made between the competing companies. Adjusted earning has a disadvantage of being exaggerated to suit the CEOs will in order to inflate the amounts for compensation.

Funds from Operation are those kinds of funds that are generates from a real estate investment and normally from the real estate investment trust. Such funds include net incomes, depreciation and the amortization value less the amount of gains made when a real estate property is sold. Funds from operation calculations indicates the general performance of the company by determining he changes that do occur in day-to-day operations of the company. It indicates which areas of financial operations that needs to be adjusted in order to meet the required targets and cash flow objectives. It determine the adequacy of funds that are needed by an organization in order to effectively carryout its mandate in process of creating goods and services. The calculation of the funds from operations can be used in determining the future funds projections of a particular company and ways of raising such funds and it can also be used in the budgeting process including making budget projections for the future operations of a company. A summary of funds from operations indicates the financial position of the company and its image in comparison to other competing companies in the same industry. Some of the disadvantages of funds from operations may be its volume of data calculated in order to arrive at the final figures might easily be ignored or overlooked.

Cash Earnings refers to the difference between the cash revenues from the operations of a company and its operating expenses. Cash earnings does not take into account the cost of depreciation. It also refer to the sum total of a trading process when all the operating expenses have been deducted from the gross revenue. The cash earnings originate from the profits that are generated through each share of a company. Cash earnings gives the true financial reflection of a company in terms of the amount in holds in the form of cash or other most liquid assets that can easily be turned into cash. Cash earnings reflect the market conditions of an economy regarding hoe the shares are trading in that particular economy from one country to the other. Cash earning does not show a clearer projection of the future cash flows into the company.

Free Cash flow is a general term that is used to refer to the amounts that the company is generating in terms of profits from it day to day business. It shows how profitable the company may be in respect to other immediate competitors. It show the ability of any business to cash that can be used in daily operations of the business. Free cash flows gives the firm a higher value its stock compared to the competing companies. The cash flow statements can be used to determine the future financial stability of the business. Free cash flows may reduce risks and uncertainties that may accrue in the process to conducting a business. It is disadvantageous since a stable cash flow may only be realized in the long-term operations of the business.

Earnings before Interest and Tax refers to the profits earned on the operational and non-operational revenues less interest and tax. It can be used to find the projections of a company in comparison with the most viable competitors. One of its disadvantages is that is does not indicate the effect of interest and taxes on the general operations of the business.

Net operating income refers to the profitability of any business and is calculated by first finding the net revenue then subtracting all the operating expenses. It is used to indicate if a firm has the ability to generate the required income. It can be used to determine the company’s capitalization rate and the amount of capital required by a firm for an effective running of the company. It also identified which investment areas needs to be seriously funded in order to maintain a particular profitability rate. Net operating income statement gives a detailed report that can be used for making viable business decisions. It has the disadvantage of difficulty in categorizing the type or kinds of business expenses.

Return on invested capital this an excess amount of what a company makes over the weighted average cost of capital. Return on invested capital can be used by managers in making management decisions regarding the performance of various levels of performance. It can be used for comparison with others companies within the industry. It also measures the marketing and management efficiency in handling the operations of the company. One of the disadvantages that may accrue as a result of using return on invested capital is that it uses approximated values and projections in its arithmetic calculations hence reducing the confidence of investors. It also does not recognize that available intangible opportunities affecting the market and the company. It contains incomplete tools used in the analysis of data. Other types of non-GAAPs highlighted here are modified funds from operating operation (MFFO) as well as the broad cash flow (BCF).

Non-GAAPs measure are not only used by the management and the company directors but other stakeholders are also interested in the statements. The stakeholder may include the investors, employees, lenders, the government, suppliers and the general public. In an efficient market, all the state holders an equal access to information relating the market conditions and any other factor that may influence the economic condition. All the stakeholders need such information in order to make viable decisions regarding the company’s operations. The government is interested in such a company because they need the financial statements in order to determine the amount of tax that the company is liable to pay to government. The investors are opportunity seekers and are ready to take risks that can result into making long-term returns with huge profit hence they need these published company statements in order to make decisions whether to invest in the company or not. The employees are interested in such statement in order to determine whether the company will continue employing them or not. The suppliers are interested in knowing whether the company will continue in operation in order to give them a continuous supply opportunity in the near future. The public are interested in knowing whether the company will continue offering them goods and services. Inefficient market is a kind of market situation where the available information is only known by a small segment of the market (Rao, 2007). Information asymmetry is a situation in the market where the buyers and sellers have varied information regarding the availability of goods or services or any others information that is related to the operations of the company and the market trends. George Akerlof, Michael Spence and Joseph Stiglitz in 2001 came up with the theory of information asymmetry. They realized that the information asymmetry is caused by the uncertainties in the market that are relating to the quality uncertainties. Dr. Kelly argues that the management of various do always abuse the use of generally accepted accounting principles hence lowering its credibility in the market place. Such abuses leads to bad earnings management and vice versa (Soon, 2011). Earnings forecasts are majorly done either on quarterly basis, half yearly basis (semiannually) or annually. They indicates the financial performances of the company at some specific points in times or after a given trading periods. They show how the firms perform in terms of the profits or the revenue generated over a given trading period. Sometimes the non-generally accepted accounting principles do not give the full disclosure of the financial position of a company. It is therefore for firms trading with specific company to use the slogan and phrase of buyer be aware of the rightful information in the market. There should be a willing seller and the willing buyer. Sometimes the directors and the managers of a company may report the financial statements with a motive of misleading the public or the government, investors, suppliers with some hidden agenda of compensating against losses incurred or in order to avoid paying of hefty taxes to the government. Lack of full disclosure may also mislead the supplier who largely depends of the financial statements of the company in order to determine their net worth and their ability to pay for the good supplied to them by suppliers. Non-GAAPs measures are always intended to produce relevant information to all other relevant stakeholders who have interest in the company. The information produced is supposed to give guidance on the decisions made regarding the investment opportunities. Quality reporting has a positive relationship with non-GAAPs measure. Quality reporting attracts the users of the financial statements hence making the necessary judgements and decisions. Regulations and governance controls the operations of various types of companies by ensuring that they remain within the bounds of the business they registered for and that they are adhering to the current laws and policies.

Conclusion

The study by Dr. Kelly Wee Kheng Soon show a strong relationship between non-GAAPs measures and the various study variables. George Akerlof, Michael Spence and Joseph Stiglitz arguments on non-GAAPs measures also indicates the different methods of measurements and their correlation to the study variable. It is therefore recommended that a further research be carried on the effect of non-GAAPs on the foreign exchange.

References

Rao, A. (2007). A Theory of Market Efficiency. A Theory of Market Efficiency, 1-36.

Soon, D. K. (2011, March 2). Earning Management: Is it Good or Bad? Retrieved from SSRN: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1775400