The Pitfalls of Non-GAAP Metrics

• Published in: MIT Sloan management review Vol. 59; no. 2; pp. 57 - 63
• Main Authors: Sherman, H David, Young, S David
• Format: Journal Article
• Language: English
• Published: Cambridge Massachusetts Institute of Technology, Cambridge, MA 01-12-2018
• Subjects: Accounting; Business metrics; Cash flow; Compensation; Corporate profits; Costs; Earnings per share; Executives; Financial performance; Financial statements; GAAP; Initial public offerings; International Financial Reporting Standards; Losses; Public companies; Stockholders; United States > US
• ISSN: 1532-9194

In 2011, Groupon Inc. announced plans for a highly anticipated initial public offering. But enthusiasm for the offering waned when the US Securities and Exchange Commission issued a comment letter questioning Groupon's use of a profit metric it called "adjusted consolidated segment operating income." To our knowledge, no company had ever used that metric before; it was intended to measure operating profit without including marketing expenses, stock-based compensation, and acquisition-related costs. Management argued that a $420 million loss from operations reported on its 2010 income statement should really be considered a $60 million gain. For decades, companies have used custom metrics that don't conform to generally accepted accounting principles (GAAP) or international financial reporting standards as supplements to their official financial statements. The proliferation of alternative metrics not only poses a problem for investors, but it can also harm the companies themselves by obscuring their financial health, overstating their growth prospects beyond what standard GAAP measures would support, and rewarding executives beyond what can be justified.