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SEC Warns Companies on Non-GAAP “Free Cash Flow” Metric

July 17, 2017

In its ongoing effort to reign in the use of non-GAAP financial measures, the SEC has been focusing on a favorite metric of financial economists: free cash flow. A recent report by Market Watch says that over the past six months, the SEC has warned more than 20 companies about use of the metric, typically calculated as cash flows from operating activities less capital expenditures. Non-GAAP measures such as free cash flow are acceptable if their use is not misleading, is accompanied by a reconciliation to the most directly comparable GAAP financial measure and otherwise complies with the SEC’s longstanding Conditions for Use of Non-GAAP Financial Measures

Free cash flow is popular with investors; “We believe free cash flow yield is the best metric to measure quality,” said an exchange-traded fund leader in recently quoted remarks. The problem is that companies use the metric in different ways. According to the SEC’s May 2016 compliance and disclosure interpretations on Non-GAAP Financial Measures, “this measure does not have a uniform definition and its title does not describe how it is calculated.” Based on the recent score of SEC letters to issuers, the regulator continues to be concerned about potentially inappropriate use of the free cash flow metric. For more on the use of non-GAAP financial measures, see the Ticker posts from May 5, 2016, and May 20, 2016, on the SEC’s guidance and from June 1, 2017, on the creative presentation of non-GAAP financial measures in the video gaming industry.

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