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Investors suggest FASB develop ‘best practices’ proposal on rules for key performance indicators

A panel of investment analysts suggested that the FASB develop a “best practices” proposal to create consistency around key performance indicators (KPIs)—metrics that show how well a business met its goals in a reporting period.

The proposal could include a starting point minimum requirement for firms to comply with or be required to explain “the number adjustments that deviate from the FASB’s best practice or even from peers,” the Investor Advisory Committee (IAC) told the board on Nov. 2, 2023.

The guidance would help to standardize key items investors typically utilize to weigh how a business is faring, analysts said, adding that it could be tough for the board as views tend to differ.

“We’re looking for a starting point in metrics that can be used across all industries, and I think most of the team agreed things like EBITDA, free cash flows” are generally used but would be hard to define, said Ronald Graziano on behalf of the group. “If you ask 10 people how to define EBITDA, free cash flows at 10 companies, you may get 10 different answers so this could lead to even more adjusted versions for companies,” said Graziano, also managing director, global accounting & tax research at Credit Suisse Group. EBITDA is the acronym for Earnings Before Interest, Taxes, Depreciation, and Amortization.

Other KPIs flagged were: same store sales, organic sales, and foreign exchange (FX). Industry-specific metrics would be challenging to standardize but the board could put together a starting list, utilizing artificial intelligence (AI) to compile certain data, the discussions indicated.

“What are the most relevant KPIs per industry? this could be difficult but this is something that could be pushed back on companies where ‘what does the chief decision officer, person’ use to understand the performance of the company?’” Graziano said. “We could also use things like AI and look at hundreds of, thousands of conference calls, press releases, what are the most commonly disclosed KPIs across the board, as well as by sector and that could be a starting list too.”

The IAC is a standing committee composed of 10 senior analysts from different companies who advise the FASB from the perspective of users of financial statements. The panel meets twice a year with the board.

Most of the discussions were privately held, taking place to enable the FASB to better gauge whether to advance the topic from its current research stage to a rulemaking project on its technical agenda. Research started last year. Next, the full board will decide at a future meeting whether it is feasible to develop GAAP in this area.

KPIs guide the questions analysts ask

In general, KPIs provide a guide about what questions to ask, IAC members said. A definition for EBITDA, for example, would reveal the adjusted number that companies give.

“If there is a big difference this enables investors to look at that and say ‘why is there a big difference’ and ask the right questions and dig a little deeper, so I think it would be good to see the outliers between a definition of EBITDA and then what the companies adjust,” said Dennis Neveling, managing director and analyst, global consumer staples at Lazard Asset Management. “One KPI that Ron mentioned that I just want to add to is organic sales growth. It’s a very common one in the industry that I analyze and it’s one that’s probably helpful across other industries as well,” he said. “So if we could agree on a definition that is something where it will be helpful for investors to get a better understanding of the underlying growth rate. So adjusting for FX and acquisitions over time and having that rate consistently applied I think that would be helpful for investors.”

Further, John Helfst, managing director at 1919 Investment Counsel, pointed to a test case that was published by NAREIT, which defines funds from operations (FFO) for real estate investment trusts (REITs). Real estate companies use FFO as a measurement of operating performance.

“REITs are 8, 10% of the small cap index, the largest subsector in ‘the Russell’,” said Helfst. “I’ve spent a lot of time analyzing it and the FFO was a very useful measure for me from a price to FFO valuation metric as well as just normalization, standardization of results.”

The Russell Helfst mentioned is the Russell 2000 Index, a small-cap U.S. stock market index that makes up the smallest 2,000 stocks in the Russell 3000 Index.

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