Bob Schneider is a Partner in 
Wilson So is the Director of Hitachi America, Ltd. Non-GAAP Data and XBRL
Written by Ralf Frank Posted on February 15, 2008
Ralf Frank is Managing Director at DVFA (the German Society of Investment Professionals), a division of EFFAS, the European umbrella of investment professional societies with more than 14,000 members in 25 countries. He is EFFAS’s delegate on XBRL as well as a member of several internal and external bodies on financial reporting and financial communication. In this post he writes about investment professionals use of so-called non-GAAP data and describes two specific examples. You can read more about this topic in the white paper he co-wrote entitled XBRL for Financial Analysts and Professional Investors.
Accounting experts often use the term “non-GAAP” to refer to data items that are not governed by generally accepted accounting principles. Financial non-GAAP items include EBIT, EBITDA, and other earnings measures, while nonfinancial non-GAAP data may depict share-of-market, CO2 emissions, or staff turnover.
My colleague Chris Dreyer recently challenged me on the term financial non-GAAP by pointing out that, strictly speaking, for investment professionals the term financial non-GAAP does not apply. Why? Any calculation, KPI, or earnings measure based on financial GAAP data is nothing but a deduction or a derivative of financial GAAP data, since it is composed of line items from the standard reporting package (i.e., balance sheet, P&L, and cash flow statement). The idea that a corporate report includes an earnings measure but the constitutive elements cannot be traced back to the standard financial reporting package may be a common phenomenon but is certainly not desirable. Investors and financial analysts would always want to assume that earnings measures rest firmly on fully audited GAAP data.
Understanding what investment professionals can do with XBRL requires us to (at least temporarily) abandon some fundamental beliefs about capital markets. Do investors read the standard reporting package? Well, some may, but the majority manage portfolios and analyze stocks under stringent time-constraints. Typically, investors use Thomson, Reuters, Bloomberg, and FactSet for aggregated and ready-to-use information. Financial analysts may belong to the group of users that reads financial information in more detail and in fact mines deeply into reporting packages. Yet they typically have what I would call trails and pain points — in other words, areas they selectively read because that is where they may find weak spots in, for example, financial position.
Investment professionals are heavy users of financial non-GAAP data. Imagine the process of financial analysis as a pyramid: it starts with getting an outline of the financial performance of a corporation, as well as its business issues and stock data. Granularity is the applicable term. You need select GAAP data like revenues and margins, and you also look at financial non-GAAP items such as EBIT. Within the process you dig deeper into the financials, you look at certain (not all!) line items, you compare your spreadsheet-based model with actual performance, and so on. Chances are you never go through the balance sheet line by line.
Has all the good work done by the XBRL community, i.e., the taxonomies that are mainly focused on GAAP, thus been in vain? Clearly no! When we look at financial non-GAAP data (which is what I am proposing to the XBRL community to do), we clearly need GAAP data as the source. Here is an example.
The majority of listed companies have small market capitalizations as well as small floats. When brokers don’t see a chance to generate orders with a stock they will not cover it. Not being covered is equivalent to lacking institutional reach, which results in low liquidity a vicious circle. The majority of companies in our capital markets are covered by fewer than five financial analysts. This is true worldwide.
On the other hand, investors are always on the lookout for an undervalued company with a solid growth story, and they like it even better if they are first to discover the stock. Most global fund management companies systematically employ a function to screen capital markets for undervalued stocks. The process entails identifying lesser known stocks, developing their base profile (financials, performance data, non-GAAP data such as EBIT, stock data etc.), and bringing them to the attention of the fund manager.
What can small caps do to increase their capital market visibility? They should provide capital markets with an XBRL profile sheet that contains a sufficient number of financials including some GAAP items but mostly non-GAAP performance data to allow for a sufficiently granular profile of the company. A sufficient number would be some 20 to 25 items, including past-performance and forward-looking information. This profile sheet should sit on the homepage of the corporation and might be targeted at fund managers by simple email. An XBRL profile sheet would in colloquial terms serve as an entre or a business card. That is a neat and, as experts of XBRL tell me, relatively simple use of XBRL.
Investment professionals will love it. It would show that corporations understand the way investors work. And it could be the beginning of a long friendship. (No need to bother about providing more details by the way: should a stock whet the appetite of a fund manager, the fund management company would quickly identify a broker analyst who would provide equity research.)
Are there other examples of non-GAAP uses for XBRL? The European Federation of Financial Analysts Societies has set up a commission on environmental, social, and governance issues, or ESG. The job of the commission is to gather and define the requirements of investment professionals in terms of ESG reporting. ESG is in demand by many fund managers and financial analysts; however, integrating predominantly prose from corporate sustainability reports is simply impossible for financial analysts. The commission has coauthored a set of more than 25 KPIs for ESG jointly with DVFA, which have been surveyed globally with fund managers and financial analysts. These KPIs build a reporting framework of quantitative, measurable data which can be easily analyzed, compared against benchmarks, etc. A team of experts is currently working on creating an XBRL taxonomy for these KPIs so that corporations soon will report their ESG data in XBRL.
XBRL can do a lot with both GAAP data and non-GAAP data alike. As a trained marketing man and a proponent of modern financial reporting, I am hungry for real-world XBRL projects that provide substantial value-added to users. The XBRL community should continue to work on XBRL GAAP taxonomies as the constituent elements for the financial non-GAAP data investment professionals handle every day. At the same time, we should also think of smaller projects in less scrutinized areas. ESG, intellectual capital, corporate governance, and stock selection are just a few examples that offer rich possibilities.