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Many companies report non-GAAP net income to get investors excited. How does it differ from GAAP income and how should you analyze it?

By Mike Price – Updated Sep 6, 2024 at 1:53 PM EST

Key Points

GAAP standards provide uniform financial reporting, critical for investors and auditors comparing companies.
Non-GAAP results adjust GAAP figures to highlight specific financial aspects, but they require careful scrutiny.
Investors should verify non-GAAP adjustments and assess the long-term implications of these adjustments on investments.

When you read financial statements, you may see GAAP vs. non-GAAP figures reported. All public companies in the U.S. are required to use generally accepted accounting principles (GAAP). Financial statements created using these principles are filed on a quarterly basis. Many companies choose to also report their own non-GAAP financials.

What is the difference between the two? Let's go over GAAP vs. non-GAAP and what you should do if a company reports both.

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A graphic comparing the differences between generally accepted accounting principles vs. non-GAAP measurements. — Image source: The Motley Fool

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When you use EBITDA, you don't have to worry about whether a company took on more debt that's reducing income with interest expense. You don't have to adjust depreciation because capital expenditures are materially higher. It's an easy back-of-the-envelope calculation.

Of course, many non-GAAP (also called pro forma) reports of income aren't this easy. Companies will make all sorts of changes to net income to look better.

They'll add back depreciation because it is non-cash. They'll add back restructuring charges and say they're a one-time thing. Insurance companies will add back catastrophic losses if they think the losses aren't likely to recur. Some companies will even adjust the reported numbers of a recently acquired business to subtract out expenses it believes will be reduced with "synergy."

As an investor, all of this makes it hard to trust non-GAAP numbers, and there's a long history of companies using non-GAAP to mislead investors. As long as the company reports GAAP financials as well, it can say anything it wants (as long as it isn't untrue, of course) with non-GAAP numbers.

For example, one-time costs suddenly become recurring costs. Synergies that were expected don't happen. And non-cash expenses exist in GAAP for a reason.

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A chart showing the differences in UPS gaap and non-gaap net income — Image source: UPS.

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That's quite a difference (more than $6 billion), and you can see that UPS isn't a stranger to adjustments since it also reported much higher non-GAAP EPS in 2019.

What's the story here? For UPS, the main addback in both years is charges GAAP required it to take to net income for shortages in its pension plan. The charges are so high that the company did a separate presentation on them after reporting its earnings.

The gist of the charge is that UPS did not estimate the demographics of its employees well and used too high of a discount rate when it calculated how much it needed in its pension plan to meet its obligations. It missed the mark by quite a bit and had to take a total of $7.72 billion in charges in 2019 and 2020.

The good news for investors is that the company has stopped doing new pensions for non-union employees and will no longer do pensions for any employees after Jan. 1, 2023. Like most businesses did decades ago, it will switch to a defined contribution plan.

It's obvious why UPS chooses to report non-GAAP (remember the company just calls it adjusted) EPS. Pension charges are part of doing business, but with the changes UPS has made to the program, management doesn't think these charges will recur. This is where you come in as an investor.

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