Thursday, August 18, 2022

What is GAAP? | GAAP Vs Non GAAP EXPLAINED

Accounting is the language of business. Likeany language there's a lot of nuance and jargon that needs to be fully understoodif you hope to speak the language fluently one of the terms that confusedme the most early on was the concept of GAAP and Non-GAAP. What do those termsmean and why are they important? We'll tell you in this video. My name is BrianFeroldi and my name is Brian Stoffel thanks to Quartr for sponsoring today's videookay brian let's get out with it what the heck does GAAP mean GAAP is like an acrosticpoem that's an acronym it stands for generally accepted accounting principles now whatdoes that mean? these are commonly recognized set of rules and procedures that are designedto govern corporate accounting and financial.

Reporting in the united states now in the u.s GAAPaccounting practices were developed jointly by the FSB and the GASB that stands for the financialaccounting standards board and the government accounting standards board that means that GAAPaccounting rules are applied to governments and non-profits as well as profitable corporations. Sowhat does non-gaap mean? non-gaap just means using accounting practices that do not comply with GAAPstandards. so why would a company want to use non-GAAP metrics? Well it doesn't make senseto have one size fits all rules GAAP accounting rules are black and white and to try andapply them across the board misses some important nuances by allowing companies to offerup their own Non-GAAP metrics investors can get a much more detailed view of the complex nature of abusiness now there are several instances in which.

GAAP and Non-GAAP accounting cannot comply witheach other one of the biggest reasons why we see this happen in today's environment is due to stockbased compensation stock-based compensation is simply when a company uses its own stock in orderto pay its employees & its management. now there's a huge debate within the investment communityas to whether or not stock-based compensation should count as an expense according to GAAP rulesit should be counted as an expense which will obviously then pull down the net income for thatcompany however when looking at a non-GAAP basis companies often exclude stock based compensationas an expense on their income statement that obviously biases up their income statementto make it look better than it is another example would be depreciation and amortization these arenon-cash charges in nature however on a GAAP basis.

They count as expenses in most cases if acompany offers non-GAAP measures they will back out depreciation and amortization becausethere's no cash going in or out of the company based on this at the time another relatively newcategory is unrealized gains and losses under GAAP accounting those gains and losses are accountedfor on the income statement but oftentimes they're non-operating in nature that's why they'reoften excluded when looking on a non-GAAP basis and finally we've got to think about if a companydecides to pay off its debt early obviously that's a really good thing for the company however ona GAAP basis all the money that left its coffers because of that count against the net income ona non-GAAP basis it's treated as a more positive event and they don't count all the losses fromthat payoff now there are a lot of common metrics.

That investors use when describing a businessthat often comply with non-GAAP accounting a very common one is called EBIT EBIT simply standsfor earnings before interest and taxes essentially EBIT is a look at a company's operating incomewhile excluding expenses such as interest and taxes a close cousin of EBIT is EBITDA which isearnings before interest taxes depreciation and amortization it means you're subtracting out thesame things that you did in EBIT however you're also pulling out depreciation and amortizationfrom your operating expenses how about another non-GAAP term that we both love and use all thetime in this channel free cash flow that is a non-GAAP metric but we think it's a wonderful wayto look at how profitable a company actually is or if you invest in software as a service or SaaSstocks you've obviously become familiar with the.

Dollar based net retention or dollar based netexpansion rates this measures how much money a cohort of customers spend from one year to thenext while factoring out new customers that's obviously important because it lets you knowwhether or not the product is resonating with its customers finally let's talk about the bigone non-GAAP earnings per share this is a very common metric that a lot of companies reportto show how profitable they were during a given period now given all those charges that we talkedabout that are differences between gap accounting and non-GAAP accounting there can often bea wide difference between a company's GAAP earnings per share and its non-GAAP earnings pershare often times under GAAP accounting a whole bunch of expenses are included while on non-GAAPaccounting those expenses are often excluded that.

Can lead to wide differences in the company'snet income and hence its earnings per share all right let's show an example that really hammershome the differences between GAAP and non-GAAP accounting by looking at it easy to understandbusiness Walmart before we do that we wanted to give a shout out to this video sponsor quarterquarter's mission is to make every interaction between companies and their investors meaningfulQuartr does so by providing frictionless access to conference calls investor presentationstranscripts and earnings reports from markets all around the world straight to your pocket forno cost i've personally been using Quartr for over a year now because it makes it so easy to listenand track my favorite investors conference calls and i love that you can fast forward skip andeven rewind the call if you're interested in.

Giving Quartr a try for free simply visit the appstore of your choice and search for quarter that's q-u-a-r-t-r thanks Quartr for sponsoringthis video okay brian let's take a look at Walmart third quarter earnings of 2021 in whichit recorded earnings per share of a dollar eleven that's on a GAAP basis right and Walmart did agreat job of making it easy to see how a dollar eleven doesn't really tell the whole story here'swhy first the company showed that it recognized an unrealized gain in some of its equity investmentsin other words Walmart held shares of some other companies and those shares went up between the endof the previous quarter and the end of the current quarter they said that doesn't make sense to addon to our earnings per share because it doesn't reflect our core business so we will subtract outthat gain on the flip side Walmart also paid off.

Some of its debt during the period that resultedin an $0.86 hit to GAAP earnings per share during the period or $0.67 after accounting for taxesthis was a GAAP charge but management doesn't believe that it should be penalized for thatbecause of that it's adding back that $0.67 cents when looking at its non-GAAP earnings so let'sreview what this means the company reported gap earnings per share of $1.11 however it subtractedout unrealized gains that it recognized from some of its investments bringing it down to $0.78 pershare finally the company needed to add back in money that it lost on a GAAP basis for gettingrid of that debt early when you factor all that in earnings per share on a non-GAAP basis werea dollar and $0.45 that's a $0.30 difference from where it was on a GAAP basis and whenlooking at those two numbers me as an investor.

I actually care a lot more about that $1.45 innon-GAAP earnings than i do about that a $1.11 GAAP earnings and obviously depending on whichnumber you can use that plays a big difference on the company's current valuation let's showanother example that showcases that stock based compensation thing that we talked about earlierbrilliantly let's take a look at Fiverr recent results in the third quarter of 2021 Fiverrreported a GAAP loss of $0.39 per share or about $14 million dollars that sounds bad however duringthe quarter the company also paid out $15 million dollars in stock-based compensation that was anon-cash charge if you exclude just stock based compensation the company would have swung from aloss to a profit but that wasn't all the company also had to account a $5 million charge on someof its convertible notes again a non-cash charge.

That would have added to those gains so whenyou account for those two major differences the company actually reported a non-GAAP net incomeof almost $8 million during the period that's a $22 million swing from a GAAP and non-GAAP basisand when we're talking about non-GAAP earnings per share the company reported $0.21 positive that's ahuge difference from a loss of $0.39 per share now we're not here to debate whether GAAP or non-GAAPaccounting is better or should always be used i personally always look at the GAAP and non-GAAPnumbers myself and see what the differences are so that i can make decisions as an investor howeverit is important that all investors understand the vagaries of GAAP and non-GAAP accounting so theycan make better investing decisions Brian's Out

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