GAAP Vs. Non-GAAP Earnings

GAAP Earnings

Companies report their GAAP earnings in the standard income statement. The construction of an income statement must follow certain GAAP rules. The revenue recognition principle and expense matching principle dictate which revenue and expense items may go into an income statement. Without such a universal standard, it's impossible to compare a company's current earnings performance with its past performance and performances of other companies.

Non-GAAP Earnings

Companies may release their non-GAAP earnings based on management's need of emphasizing earnings performance of particular operational areas. Non-GAAP earnings often are more publicized to better attract investors' attention. When using non-GAAP earnings, companies may exclude certain expense items that management believes are insignificant to their current operations. Such expense exclusions help improve earnings performance. Conversely, any inclusion of non-GAAP revenue items such as customer deposits or prepaid cash proceeds also results in better earnings numbers.

Overall Earnings Performance

GAAP earnings tend to be inclusive in that they consider earnings from both the operating section and non-operating section, continuing operations and discontinued operations, unusual items and extraordinary items. Another term for GAAP earnings is the mostly reported net income, which incorporates all revenue and expense items in a income statement. However, GAAP earnings may not be useful in analyzing a company's cash flow situation, which has particular relevance for creditors, because GAAP earnings are accrual based rather than cash based.

Specific Earnings Performance

While non-GAAP earnings may have a tendency to manipulate earnings numbers, they also provide legitimate uses for both investors and management. Sometimes, investors prefer certain non-GAAP earnings to better gauge the core performance of some business operations, because GAAP earnings are non-specific and too inclusive. For example, financial analysts would exclude any current unusual or extraordinary items that happen infrequently so that they could better predict a company's future growth prospects.