Generally Accepted Accounting Principles (GAAP) and non-GAAP reporting are two different sets of guidelines for financial reporting. GAAP is a set of rules and principles that companies in the United States must follow when preparing their financial statements, while non-GAAP reporting is a set of guidelines that companies can choose to follow in addition to or instead of GAAP.
For a software startup company, GAAP would require them to follow a set of rules around revenue recognition, software development costs, and other accounting matters. Non-GAAP reporting, on the other hand, would allow the company to report financial information in a way that they believe better represents the performance and financial position of the company. However, non-GAAP reporting can be less comparable, reliable and objective than GAAP reporting.
It’s important to note that while non-GAAP reporting is not required by law, the SEC has rules that companies must follow if they choose to use non-GAAP measures in their financial reports.
Pros of GAAP reporting:
1. Consistency: GAAP provides a consistent framework for financial reporting, which makes it easier for investors and analysts to compare financial statements of different companies.
2. Transparency: GAAP rules are designed to promote transparency and provide an accurate picture of a company’s financial position and performance.
3. Objectivity: GAAP reporting is based on objective standards and guidelines, which helps to minimize the potential for bias or manipulation.
4. Auditability: GAAP financial statements are auditable, which means they have been reviewed by an independent auditor to ensure they are accurate and complete.
Cons of GAAP reporting:
1. Complexity: GAAP can be complex and time-consuming to implement, which can be a burden for small companies.
2. Inflexibility: GAAP rules may not always align with a company’s specific business model or industry, which can make it difficult to accurately reflect the company’s financial performance.
3. Cost: Complying with GAAP can be costly, as companies may need to hire additional staff or consultants to ensure compliance.
Pros of non-GAAP reporting:
1. Flexibility: Non-GAAP reporting allows companies to report financial information in a way that they believe better represents their performance and financial position.
2. Customization: Companies can use non-GAAP measures to highlight specific aspects of their business that they believe are important to their investors.
Cons of non-GAAP reporting:
1. Lack of comparability: Non-GAAP measures can be less comparable between companies, which can make it difficult for investors and analysts to compare the performance of different companies.
2. Lack of reliability: Non-GAAP measures may not be as reliable as GAAP measures, as they are not based on objective standards and guidelines.
3. Potential for manipulation: Non-GAAP measures may be subject to manipulation or bias, which can result in an inaccurate picture of a company’s financial position and performance.
4. SEC rules: Companies must follow SEC rules if they choose to use non-GAAP measures in their financial reports.
For a Software as a Service (SaaS) company, it is generally considered better to follow Generally Accepted Accounting Principles (GAAP) when preparing financial statements. This is because GAAP provides a consistent framework for financial reporting, which makes it easier for investors and analysts to compare financial statements of different companies.
Additionally, GAAP reporting is based on objective standards and guidelines, which helps to minimize the potential for bias or manipulation, and provides an accurate picture of a company’s financial position and performance. Furthermore, GAAP financial statements are auditable, which means they have been reviewed by an independent auditor to ensure they are accurate and complete.
However, it’s important to note that while it is better to follow GAAP, a SaaS company can also provide non-GAAP financial measures alongside with GAAP financials to give more context or additional information to their performance. But the non-GAAP measures should be reconciled with the GAAP measures, and the company should follow the SEC rules when using non-GAAP measures in their financial reports.