Non-financial metrics: The unregulated frontier of quarterly reports
Non-financial metrics are now a key part of a business's narrative. But the CFO of the UK's latest unicorn company fears it's becoming a Wild West.
Three-quarters of Anup Singh’s job as CFO on Anaplan is storytelling. “I know the business model and I need to be able to explain it to shareholders, investors and stakeholders, including our employees,” he told AccountingWEB.
Anaplan's story is a successful one. Founded in 2006 in Yorkshire, the business offers cloud-based enterprise planning software. It made the move to California once the business gained traction and late last year Anaplan achieved 'unicorn' status through a $1.4bn valuation.
A big part of telling Anaplan's growth story is metrics, both financial and non-financial. “You’ve got the GAAP accounts which give you the P&L, the balance sheet and the cash flow. But the problem with the financials is that they’re backwards-looking, they don’t give you any insights into how the company is really doing.”
One result of that has been the myriad creative non-GAAP measures that have sprung up. In a recent article for AccountingWEB, Chris Goodfellow detailed some of these figures. Most notably, WeWork’s ‘community-adjusted EBITDA’ removed non-recurring costs from its profit numbers, turning a net loss of $933m in 2017 into a community-adjusted EBITDA of $233m.
Singh acknowledges these non-GAAP numbers, but he’s more concerned about non-financial metrics. With non-GAAP earnings there are at least some guidelines, he said, and companies display their GAAP earnings alongside their non-GAAP ones.
“A lot of companies in this day and age are valued on metrics,” said Singh. “It’s about metrics, not the financials. The classic example is Netflix. Every quarter, if we look at earnings for Netflix, the reaction from the market all comes down to the number of subscribers that the company has added during the quarter.”
So the metric everyone cares about isn’t the revenue, it’s not cash flow, it’s not earnings - it’s that subscriber number. Singh also points to another prominent example like Tesla: “The metric all the investors are looking at is how many cars were you able to manufacture in the quarter. Basically, are you on track with manufacturing and scheduling?”
All of these are indicators, or metrics, or KPIs. But these are not numbers that are necessarily defined. Anaplan, for example, is a cloud software company. We’ve witnessed a boom in cloud companies in the last decade. “Practically everyone is moving to a model of cloud,” explained Singh. “And a lot of the indicators that investors are looking at are the metrics, not revenue or cash flow.”
A key metric for a cloud business - or any business with a recurring revenue model, really - is rate of churn. Investors are interested in the churn number, but there’s no consistent way that companies calculate or measure churn.
“Some companies I’ve had churn when I’ve lost a customer: I used to have a customer and that customer ended the agreement. But other companies say you may also have 'shrinkage' in your existing accounts. So if you had a customer that had a hundred licenses and at time of renewal they only renewed for 80, you’ve had shrinkage, and the amount of shrinkage counts as churn.”
At Anaplan, Singh falls into the latter camp and looks at the number of customers that have moved on and the shrinkage of the company’s existing accounts. “Another hazy issue is how and when you do the measurement of churn. Is it on the date you receive the notice of customer intent to churn in future? Or is it the legal date of the agreement ending? Or is it the day you switch the service off? It’s really unclear what you should include and exclude in the calculation.”
This is just a single metric where there’s no consistency. Extrapolated across a whole suite of ill-defined metrics, it quickly becomes difficult to compare companies.
“There’s no GAAP equivalent. There are no accepted views and it's entirely up to the company. I have a conversation with my peers in the industry and just ask ‘how do you do it?’ I may get a range of diverse opinions and I’ll step back and choose the methodology I like and the one I have the data for.”
"The metrics will only become more important as more businesses move to a recurring revenue model. As the CFO, it’s my responsibility to articulate our business to investors, shareholders and stakeholders.
“The financials are all backwards-looking, and as CFO, I encourage investors to look at the metrics. The financials are only one part of this story, and if you really want to look into the future and how to think about our business, the thing you want to look at is X.”
So Singh isn’t arguing against metrics, he’s arguing for a controlled application of them. “Even if we can only say ‘these are the top 20 metrics in this industry and here’s the best approach. Or get the Big Four accounting firms to come up with a manual. At the moment, auditors don’t express an opinion on your metrics, it’s not something that’s in their remit.”
But whether smaller, high growth businesses want more rules and regulations is another story. Anaplan, an established enterprise with a $1.4bn valuation, can take more regulation in its stride. But a leaner startup (and potentially a scrappy competitor) could struggle.
But Singh still sees it as a matter of necessity. “In an age of disruption, there can be a cowboy attitude at times. Everyone is innovating like crazy. There isn’t any consistency. In many respects, you could almost be making these things up. And we’re getting to a stage soon, where somebody has to come up with some broad guidelines.”