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The Financial Accounting Standards Board (FASB) is currently seeking public feedback on how to define and disclose key performance indicators (KPIs), including metrics that don’t conform to U.S. Generally Accepted Accounting Principles (GAAP). Stakeholders have until April 30, 2025, to submit comments.
FASB research project
In a significant step toward KPI standardization, the FASB recently issued an Invitation-to-Comment No. 2024-ITC100, Financial Key Performance Indicators for Business Entities, on November 14, 2024. The FASB has identified two potential paths for this potentially transformative project:
- Standardizing KPIs. This approach would involve defining metrics within GAAP financial statements. Standard definitions would enhance comparability but might reduce flexibility for companies with unique business models.
- Disclosing management’s preferred KPIs. This option would allow companies to report non-GAAP metrics, provided they meet specific disclosure requirements. This mirrors the International Financial Reporting Standards approach, which emphasizes transparency and reconciliation to GAAP measures.
Both approaches would likely require companies to disclose the components of each KPI, explain their relevance and reconcile them with GAAP metrics to ensure clarity for stakeholders.
Closeup on KPIs
KPIs are financial and nonfinancial metrics that management uses to evaluate an organization’s progress toward its objectives. In recent years, non-GAAP performance metrics have become staples in corporate earnings reports. Common examples include:
- Earnings before interest, taxes, depreciation, and amortization (EBITDA),
- Free cash flow, and
- Adjusted revenue.
KPIs differ from one company to the next based on the company’s operations and industry. For example, auto dealers might compare new vehicle sales to used vehicle sales; contractors might focus on the bid-hit ratio; and hospitals might want to know the average wait time in the emergency room or the bed occupancy rate in the intensive care unit.
Nonfinancial metrics should be specific and measurable. For instance, saying that your company wants to “provide better customer service” doesn’t produce a sound KPI. If your goal is to improve response time to customer complaints, a relevant KPI might be to provide an initial response to complaints within 24 hours and to eventually resolve at least 80% of complaints to the customer’s satisfaction.
Criticisms of non-GAAP metrics
Many KPIs don’t conform to GAAP. However, non-GAAP metrics often provide insights into a company’s performance that complement GAAP metrics, such as gross revenue and net income. However, inconsistent calculation and presentation of non-GAAP metrics have long frustrated investors and lenders.
Companies use such metrics to provide insight into core operating performance by excluding nonrecurring or noncash items. Yet, the freedom companies have in defining these metrics poses challenges related to the consistency and transparency of financial reporting. A major concern is that companies can use non-GAAP metrics to present a rosier picture of financial health.
To illustrate, suppose two companies in the same industry both report EBITDA. Company A excludes stock-based compensation, while Company B includes it. An investor comparing the two might assume that Company A is profitable, even though the exclusion obscures a significant cost of operations.
Why standardization matters
Standardizing non-GAAP metrics could deliver several benefits. First, it would help investors and lenders can make apples-to-apples comparisons across companies and industries. Clear definitions and reconciliations would enhance financial reporting transparency by clarifying how non-GAAP and GAAP metrics differ.
In addition, the frequency of U.S. Securities and Exchange Commission comment letters related to public companies’ non-GAAP disclosures has increased in recent years. Standardized definitions or disclosures could help reduce regulatory scrutiny.
Best practices for using non-GAAP metrics
While the FASB solicits feedback and considers potential changes to the accounting rules, companies can take the following measures to ensure their non-GAAP metrics are clear and reliable:
- Provide detailed reconciliations between non-GAAP and GAAP metrics,
- Disclose how each metric is calculated and explain why it’s meaningful,
- Emphasize that non-GAAP metrics provide supplementary information and don’t replace GAAP measures.
In addition, your CPA can review non-GAAP disclosures for accuracy and compliance. External assurance can build trust with stakeholders.
Next steps
The FASB invitation-to-comment provides an opportunity for stakeholders to shape the future of non-GAAP reporting. While standardization may pose challenges for some companies, the long-term benefits of increased transparency and consistency could outweigh the initial costs. Contact your accountant to discuss how the FASB’s efforts might affect your financial reporting — or if you need assistance refining your non-GAAP disclosures.
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