Hello,

Thanks for the question.  GAAP accounting stands for Generally Accepted Accounting Principles.  It standardizes the reporting rules that U.S. public companies must follow when presenting financial statements. For example, it deals with topics related to revenue and expense recognition.

The most common issues we come across that effect the income statements are those that deal with issues of unusual "non-cash" expenses.  Let's look at the example of compensation expense.  This is referring to "money" paid to executives via stock in lieu of "cash".  In the old days clever companies would pay executives in stock as a way to increase the net income figure, since this really isn't a cash expense.  In essence, stock compensation was not treated as an expense. It can also be argued that it put smaller companies that couldn't match stock compensation figures in a weak position since they would have to pay more cash to retain employees; a reportable expense on the income statement.

Eventually, GAAP accounting rules were amended to treat stock compensation as an expense so companies couldn't "artificially" inflate net income.  The irony is that many of these items are not tax deductible. So they expect the company to report less net income yet pay taxes on the income figure as if it were not treated as an expense. That is why sometimes you may notice a company with a loss paying taxes.   There are also types of non-cash gains that must be subtracted from the income statement.

Now, you must also keep in mind that under GAAP accounting, certain one time cash gains/losses that are not related to the core operating results are also reflected in the income statement; items such as the profit or loss from the sale of some land.

So...what Wall Street does in the end is omit the non-cash and one time cash items from the income statement to calculate the true earnings power of a company. These adjustments are referred to as non-GAAP and what most investors look at in order to value a company. EBITDA is also a non-GAAP figure that some investors look to.

Sometimes you can find hidden value in companies that only report GAAP numbers by reading the operating section of the cash flow statement, where non-GAAP items can be identified and added back to net income.

Formula we use to derive non-GAAP net income: {Pretax income +/- adjustments} * {1-tax rate}

We plan on soon providing more information on non-GAAP items and how to calculate non-GAAP EPS.