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Net operating income (NOI) and EBITDA (earnings before interest, tax, depreciation, and amortization) are similar metrics used to measure a company’s profitability based on its core business operations. Different industries choose different metrics. NOI is generally used in real estate to evaluate income-producing properties, whereas EBITDA is most often used to measure how efficiently a company is operating and how it compares to competitors.

Here’s a closer look at NOI vs. EBITDA, how each one is calculated, their similarities and differences, and why they are important.

What Is Net Operating Income?

Net operating income, or NOI, is a measurement used to determine the profitability of an income-producing property. NOI determines the revenue of a property by subtracting gross operating expenses from gross income. While NOI is most frequently used in the real estate industry, it can be used by any company that earns income from a property.

With NOI, a property’s gross income is everything it earns minus any losses due to vacancies.

As a rule of thumb, an expense is considered an operating expense if not spending money on that cost would jeopardize the asset’s ability to continue producing income. Operating expenses commonly include property taxes, vendor and supplier costs, maintenance and repair, insurance, utilities, licenses, supplies, and overhead costs, such as expenses for accounting, attorneys, and advertising.

Since income taxes, loan interest and principal payments, capital expenditures (money spent on improvements or repairs), and amortization and depreciation (the gradual write-off of long-term assets) do not impact the potential of a real estate investment to make money, they are not included in NOI.

A lender may look at a company’s NOI if they are applying for a small business loan, such as a commercial real estate loan.

How to Calculate Net Operating Income

NOI measures a property’s ability to generate a profit from its operations. The NOI formula is:

NOI = Gross Operating Income – Operating Expenses

Pros and Cons of Using NOI

While NOI can give potential investors and lenders a good indication of how profitable a property will be, it also has some drawbacks. Here’s a look at the pros and cons of using NOI.

Recommended: Annual Revenue Meaning and Calculation

What Is EBITDA?

EBITDA (earnings before interest, taxes, depreciation, and amortization) is used to calculate the earnings that a business has generated from its core operations.

To calculate a company’s annual earnings, EBITDA factors in the cost of goods sold, general and administrative expenses, and other operating expenses. However, it doesn’t subtract costs that are not directly related to the company’s operations, namely interest paid on debt, amortization and depreciation expenses, and income taxes on business revenue. The reason is that these costs are outside of management’s operational control.

By adding these values back to net income (which is gross business income minus all business expenses), many analysts believe that EBITDA can be a better measure of company performance because it shows earnings before the influence of accounting and financial deductions. EBITDA can also be useful for comparing firms with different sizes, structures, taxes, and depreciation.

Your company’s EBITDA may be calculated by a potential investor or by a creditor when you’re applying for a business loan because it provides a snapshot into how well your company will be able to pay its bills and maintain or increase net income.

How to Calculate EBITDA

The two most commonly used ways to calculate EBITDA include:

Option 1:
Start with net income (the bottom line of the income statement), and then add back the entries for taxes, interest, depreciation, and amortization.

Net income + Taxes Owed + Interest + Depreciation + Amortization = EBITDA

Option 2:
Start with operating income (also referred to as operating profit or EBIT – earnings before interest and taxes) and add back depreciation and amortization.

Operating Income + Depreciation + Amortization = EBITDA

Recommended: Business Cash Management, Explained

Pros and Cons of Using EBITDA

Pros of using EBITDA include:

•  It offers a clear view of operational performance by excluding non-operational expenses like interest, taxes, depreciation, and amortization.

•  EBITDA simplifies comparison across companies with different capital structures.

•  It helps assess cash flow potential and operational efficiency.

Cons of using EBITDA include:

•  It can obscure important financial costs, such as debt and capital expenditures, leading to an incomplete financial picture.

•  EBITDA may overstate profitability by ignoring non-cash expenses.

•  Investors might be misled about a company’s long-term financial health if focusing solely on EBITDA.

NOI vs EBITDA Compared

NOI and EBITDA have some similarities, but also a couple of key differences. Here’s how the two formulas compare.

Similarities

Both NOI and EBITDA measure the profitability of a business or property without including income taxes, the cost of loans, amortization, or depreciation as expenses. NOI is essentially EBITDA within a real estate context. By stripping away incidentals, both NOI and EBITDA level the playing field, which makes them useful for comparing different properties and businesses.

Banks will often use NOI or EBITDA (depending on a borrower’s industry) before giving the green light on different types of business loans. These metrics help them determine whether or not the business will have the cash flow to pay back the loan.

Recommended: What Is the Difference Between EBIT and EBITDA?

Differences

NOI is primarily used to evaluate the profitability of an investment in a commercial or residential real estate property. EBITDA, on the other hand, is primarily used to evaluate the profitability of a company. As a result, NOI takes into account lost revenues from vacancies, whereas EBITDA does not.

Recommended: What You Should Know About Short-Term Business Loans

Example of EBITDA vs Net Operating Income

Let’s look at how NOI and EBITDA compare when they are applied to a business.

Let’s say you’re considering purchasing a multi-tenant apartment building. You know the property already brings in gross revenues of $1.5 million. Operating expenses are $500,000, and other expenses include:

•  Lost revenues from vacancies: $50,000

•  Interest: $4,000

•  Tax: $100,000

•  Depreciation: $50,000

•  Amortization: $25,000

Here’s how to calculate the property’s NOI:

NOI = Gross Revenues ($1.5 million – $50,000 in vacancies) – Operating Expenses ($500,000)

NOI = $950,000

While EBITDA is not typically used to calculate profits of real estate, let’s look at what the building’s EBITDA would be for the sake of comparison.

To calculate EBITDA, you first need to figure out net income, which is gross revenues minus operating expenses:

$1.5 million (gross revenue) – $679,000 (operating expenses) = $821,000 (net income)

EBITDA = Net Income ($821,000) + Taxes Owed ($100,000) + Interest ($4,000) + Depreciation ($50,000) + Amortization ($25,000)

EBITDA = $1,000,000

The difference between the two – $50,000 – represents the lost income to vacancies, which is not factored into EBITDA.

Recommended: Net Present Value: How to Calculate NPV

Obtaining Small Business Financing

Both NOI and EBITDA calculate a company’s profitability by subtracting operating expenses from revenues. In addition, both metrics exclude income taxes, debt expenses, depreciation, and amortization, since these expenses are not related to the company’s core operations.

The key difference between NOI and EBITDA is that NOI is used for real estate and EBITDA is used for general businesses.

When it comes to small business loans, a lender will likely look at your NOI or EBITDA (depending on your company’s industry), along with other key financial metrics, to see whether you have enough positive cash flow to comfortably make payments on the loan.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

Does net operating income mean the same thing as EBITDA?

Net operating income, or NOI, and EBITDA (earnings before interest, tax, depreciation, and amortization) are similar ways to calculate a business’s profitability. However, NOI is used for an income-generating property and EBITDA is used for a business.

Should EBITDA OR NOI be higher?

If you used EBITDA (earnings before interest, tax, depreciation, and amortization) and NOI (net operating income) to evaluate the same income-producing property, EBITDA would be higher because it does not account for lost income due to vacancies.

Can you have a negative EBITDA?

Yes, if a company has poor cash flow, its EBITDA (earnings before interest, tax, depreciation, and amortization) can be negative.

Photo credit: iStock/LumiNola

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

SOSMB-Q324-049

A balance sheet is a financial statement that shows the balance among your assets, liabilities, and equity. It can help you track the financial health of your small business and make informed decisions. You may also need a balance sheet to file taxes, secure a loan, bring in investors, or sell your business.

Read on to learn more about small business balance sheets, including what they are, what they look like, and how they can help you with your business.

What Is a Balance Sheet?

A balance sheet is a financial statement that provides a snapshot of a company’s financial position at a specific point in time. It shows what the business owns (assets), what it owes (liabilities), and the difference between the two (owner’s equity). The balance sheet follows the fundamental accounting equation:

Assets = Liabilities + Owner’s Equity

Recommended: Free Balance Sheet Templates with Microsoft Office

Assets

Assets are resources that the business owns and can use to generate revenue. They are usually listed in order of liquidity, with the most liquid assets (e.g., cash) listed first. Examples of assets include:

•  Cash

•  Accounts receivable

•  Inventory (the value of goods held by the business for resale)

•  Property, plant, and equipment (the value of long-term assets such as buildings, machinery, and vehicles)

•  Investments (the value of investments held by the business, such as stocks or bonds)

Recommended: How Much Does It Cost to Start a Business?

Liabilities

Liabilities are obligations that the company owes to external parties. These include:

•  Long-term business loans

•  Short-term business loans

•  Accrued expenses

•  Deferred tax liability (accumulated taxes that have not yet been paid)

•  Accounts payable

Equity

Owner’s equity represents the owner’s stake in the business. It is calculated as the difference between the company’s assets and liabilities and represents the amount of the company’s assets that are owned by the owner or shareholders.

This part of the balance sheet also includes retained earnings. Retained earnings represent the cumulative net income of the company that has been retained in the business rather than distributed to shareholders as dividends.

Income Statement vs Balance Sheet

Both balance sheets and income statements offer valuable information on a company’s financial health, but they differ in a few key ways.

An income statement (also known as a profit and loss statement), is a financial statement that summarizes a company’s revenues, expenses, and profits or losses over a specific period, typically a quarter or a year.

An income statement provides insight into your company’s financial performance by showing how much money the company made (revenue), how much it spent (expenses), and the resulting profit or loss. This information is also important to investors and lenders, since it indicates if the company was profitable during the given time.

A balance sheet, by contrast, shows a company’s financial health at a specific point in time. Creditors and investors look at a company’s balance sheet to understand what the company owns (assets) and owes (liabilities). The balance between those two items communicates the company’s financial health.

Here’s a side-by-side comparison of income statements and balance sheets:

Recommended: How to Read Financial Statements: The Basics

Do Small Businesses Need a Balance Sheet?

If your company brings in revenues of more than $250,000, the Internal Revenue Service (IRS) may require you to complete a small business balance sheet when you file your taxes. If your company makes less than that, it’s not required.

However, if you want to take out a small business loan, lenders may ask to see your balance sheet when you apply. If you’re looking to bring in investors or plan to sell your company, you’ll also likely need a balance sheet.

If none of those apply, it can still be wise to have a balance sheet, as it lets you know at a glance where your business stands in terms of what it owns and what it owes.

A balance sheet also offers a scannable list of assets and liabilities for comparison, so you can make sure your business is able to cover its short-term obligations. If you see that liabilities outweigh assets, you’ll need to find ways to increase revenue or raise working capital, either from investors or through financing.

Recommended: Typical Small Business Loan Fees

Benefits of Having a Balance Sheet

The benefits of having a balance sheet for your small business include:

•  Provides a clear snapshot of assets, liabilities, and equity.

•  Helps business owners make strategic financial decisions.

•  Essential for applying for loans or credit from lenders.

•  Assists in accurate tax reporting and compliance.

•  Monitors business growth and financial health over time.

•  Helps plan and manage future expenses and investments.

•  Useful for determining the business’s worth in case of sale or investment.

Recommended: 15 Types of Business Loans to Consider

Writing a Balance Sheet for a Small Business

Ready to create a simple balance sheet for your small business’s use? You have a few options.

Start With What You’ve Got

If you already use small business accounting software, you may have the ability to create a balance sheet statement directly from that software. These programs can typically build the balance sheet for you by automatically filling in all relevant assets and liabilities, often using real-time information from your bank accounts.

Ask Your Accountant

If you have an accountant who manages your books and files your taxes, they can help you generate a balance sheet and explain how it works.

DIY Your Balance Sheet

If the other two aren’t options, you can generate your own balance sheet. There are templates you can find online to use or you can create one in a spreadsheet. Make sure to include your current and fixed assets, current and long-term liabilities, and any money you (or others) have invested in the company.

Small Business Balance Sheet Example

Let’s look at an example of a balance sheet for a fictional small business so you get a sense of what yours might look like.

This sample balance sheet is in balance, since total assets ($93,500) equals total liabilities ($73,500) plus total equity ($20,000).

Recommended: Gross Profit vs EBITDA

Pro Forma Balance Sheet

Pro forma financial statements are financial reports for your business based on hypothetical scenarios. As a result, they allow you to test out situations you think may happen in the future to help you make business decisions.

A pro forma balance sheet is a balance sheet with forecasted future values — namely the assets, liabilities, and equity you wish to have in the future. These balance sheets can be useful for planning any significant changes to the business, whether you’re thinking about taking out a new loan, purchasing a large piece of equipment, or even buying another company.

Recommended: How Do You Structure a 3-Year Business Plan?

The Takeaway

The balance sheet is a critical financial statement that provides valuable information about a company’s financial position. No matter how big or small your business is, it’s a good idea to periodically generate and review the balance sheet to keep tabs on your company’s financial health and make informed decisions. By understanding the balance sheet, you can better manage your finances and position your business for long-term success.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

How do I create a balance sheet for a small business?

To create a small business balance sheet, list assets (cash, inventory, equipment) on one side and liabilities (loans, accounts payable) on the other. Subtract liabilities from assets to calculate equity. Ensure total assets equal the sum of liabilities and equity. You can use accounting software or online templates for accuracy.

Do all businesses need a balance sheet?

No, not all businesses are legally required to have a balance sheet. However, it’s highly recommended for all businesses as it provides valuable insights into financial health, supports decision-making, and is essential for obtaining loans, attracting investors, and reporting taxes.

Does the IRS require a balance sheet for all businesses?

No, the IRS does not require a balance sheet for all businesses. Sole proprietors typically do not need to provide one unless required for specific tax forms. Corporations and partnerships with gross receipts or total assets over $250,000, however, must include a balance sheet with their tax returns.

Photo credit: iStock/stockphotodirectors

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

SOSMB-Q324-033

EBITDAR, which stands for earnings before interest, taxes, depreciation, amortization, and restructuring or rent costs, is an operational efficiency metric. It’s often used by investors, lenders, and business owners to understand how well a company is performing from its primary business operations. It does this by adding back non-operational, non-recurring, and non-cash expenses to net income.

Here’s what you need to know about EBITDAR, including how to calculate it, how it’s used, and what it can tell you about your business.

What Is EBITDAR?

EBITDAR is a variation of EBITDA (earnings before interest, taxes, depreciation, and amortization), an accounting method that removes the effects of non-operational costs from net income. The only difference? EBITDAR also excludes restructuring and rental costs. (EBITDAR is also similar to adjusted EBITDA, which includes the removal of various one-time, irregular, and non-recurring items from EBITDA.)

By removing rental costs, investors can analyze companies that may have similar operations but that choose to access assets differently — some companies rent while others choose to own. Excluding rentals allows comparison of profits apples-to-apples.

EBITDAR is also an important measure if you are exploring business loans because it is often used by lenders to estimate the cash flows that a company has available for principal and interest payments.

Breakdown of EBITDAR

Here’s a breakdown of each part of EBITDAR and why each variable is important.

Earnings: Earnings are the profit a business makes off of its core operations. With EBITDAR, earnings are calculated by subtracting expenses from total revenue. However, unlike net earnings, EBITDAR doesn’t subtract all business expenses. It factors in the cost of goods sold, general and administrative expenses, and other operating expenses, but doesn’t subtract costs that are not directly related to the company’s operations, namely interest paid on debt, amortization and depreciation expenses, income taxes, and the cost of restructuring or renting.

Interest: The interest a company pays on its loans is added back to net income with EBITDAR. The reasoning behind this is that while interest is an expense, it doesn’t reflect how well the company is utilizing its debt. Businesses take on different amounts of debt for different reasons and receive different interest rates based on a variety of factors (for example, credit score, existing debt, and collateral).

Taxes: Each locality has different tax laws. Depending on where a business is located, it may have a dramatically different tax burden than another company with the same amount in sales. To better compare companies, EBITDAR removes the effect of taxes on net income. This makes it easier to compare the performance of two or more companies operating in different states, cities, or counties.

Depreciation: Depreciation is the process of writing off the cost of a tangible asset over the course of its useful life. With EBITDAR, depreciation is added back to net income because depreciation depends on past investments the business has made and not on the company’s operating performance.

Amortization: Amortization is similar to depreciation, but is used to spread out the cost of intangible assets, such as patents, copyrights, trademarks, non-compete agreements, and software. These assets also have a limited useful life due to expiration. Amortization is added back to net income in EBITDAR because this expense isn’t directly related to a business’s core operations.

Restructuring costs: The restructuring of land or a building is an expense that doesn’t occur very often for most companies. And, many analysts view it as more of an investment that could potentially help the company generate additional revenue and profits. As a result, any costs associated with restructuring are added back to net income with EBITDAR to give analysts a better understanding of how well the central business model is performing.

Rental costs: Because rent can vary significantly from one location to the next and is not within a business’s control, rent costs are added back to net income in EBITDAR. This allows for a better understanding of a company’s operating performance and potential. In addition, rent is a sunk cost, which means the expense is guaranteed to occur regardless of how a company performs.

Recommended: Partnership Business Loans Explained

EBITDAR Formula

The standard formula for EBITDAR is:

EBITDAR = Net income + Interest + Taxes + Depreciation + Amortization + Restructuring or Rent Costs

An alternative formula:

EBITDAR = EBITDA + Restructuring/Rental Costs

where:

EBITDA = Earnings before interest, taxes, depreciation, and amortization

Recommended: Debt-to-EBITDA Ratio Explained

How Does EBITDAR Work?

The premise of EBITDAR is that certain expenses can distract analysts from understanding how well a company is bringing in business. It only includes core operating expenses, and the following expenses are added back to net income:

•   Non-cash expenses

•   Non-recurring expenses

•   Non-operational expenses

What EBITDAR Tells You

EBITDAR, rather than EBITDA (earnings before interest, taxes, depreciation, and amortization), is primarily used to analyze the financial health and performance of companies that have gone through restructuring within the past year or have unique rent costs, such as restaurants, casinos, shipping companies, and airlines.

EBITDAR (like EBITDA) is also useful for measuring a company’s operating cash flow and for comparing the profitability of companies with different capital structures and in different tax brackets.

However, companies do have to pay interest, taxes, and rent, and must also account for depreciation and amortization. As a result, EBITDAR does not paint a complete picture or offer a true measure of how profitable a business is. In some cases, it can be used to hide poor choices. A company could use this metric to avoid showing things like high-interest loans or aging equipment that will be costly to replace.

Recommended: What is EBIDA?

When to Use EBITDAR

EBITDAR is commonly used when evaluating businesses in industries with significant rent or lease costs, such as hospitality, retail, or airlines. It provides a clearer view of operational performance by excluding expenses like interest, taxes, depreciation, amortization, and rent.

This metric is particularly useful for comparing companies with different lease or property ownership structures, as it standardizes performance across various financial arrangements. Investors and analysts rely on EBITDAR to assess profitability before accounting for non-operational costs, helping them understand the core earnings potential of a company, especially in rent-heavy sectors.

Example of EBITDAR

Here is the income statement for Company X for 2024:

To use Company X’s income statement to arrive at EBITDAR, you would add back interest ($20,000), taxes ($120,000), depreciation ($25,000), amortization ($15,000), and rent ($5,000) to arrive at an EBITDAR of $640,000 for 2024.

Pros and Cons of Using EBITDAR

Recommended: What Is GAAP and How Does It Work?

EBITDAR vs EBITDA

EBITDAR and EBITDA are both metrics used to measure a company’s operational performance. The key difference is that EBITDAR also excludes rent costs, making it particularly useful for industries with high lease expenses, like retail or hospitality.

EBITDA, on the other hand, focuses on core earnings without factoring in non-operational costs like depreciation and interest. While both metrics assess profitability, EBITDAR offers a more specific view in rent-heavy businesses, whereas EBITDA is more widely applicable.

EBITDAR vs EBIT

EBIT (earnings before interest and taxes) and EBITDAR are both metrics used to evaluate a company’s operational performance. EBIT focuses on core earnings by excluding interest and tax expenses, making it a key measure of profitability. EBITDAR takes this a step further by also excluding depreciation, amortization, and rent, providing a clearer view of a company’s operational performance in rent-heavy industries like hospitality or retail.

While EBIT is widely applicable, EBITDAR is particularly useful for comparing businesses with significant lease obligations.

Recommended: What Is the Difference Between EBIT and EBITDA?

EBITDAR vs Net Income

EBITDAR and net income are both profitability metrics, but they measure different aspects of a company’s performance. EBITDAR focuses on operational earnings by excluding key expenses like interest, taxes, rent, depreciation, and amortization, offering insight into core operations.

Net income, on the other hand, is the company’s total profit after all expenses, including non-operational costs like interest, taxes, and depreciation, are deducted. While EBITDAR helps assess operational efficiency, net income reflects overall profitability and is more comprehensive for understanding a company’s financial health.

The Takeaway

EBITDAR, or earnings before interest, taxes, depreciation, amortization, and restructuring or rent costs, is a valuation metric of a firm’s profitability without considering the tax rate and the capital structure of the company. It aims to measure a company’s profitability from its core operations.

While similar to EBITDA, EBITDAR goes a step further by removing the effects of rent or restructuring costs. This makes it a better tool for companies that have non-recurring or highly variable rent or restructuring costs, such as casinos and restaurants.

Calculating EBITDAR can be helpful for seeing how your business performs from one quarter or year to the next, as well as how it compares to other businesses in your industry. It may also come into play if you’re applying for a business loan. Banks and other lenders often look at EBITDAR (or EBITDA) when deciding whether your business is a risk they’re willing to take on.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

What is the difference between EBITDAR and EBITDA?

EBITDAR (earnings before interest, taxes, depreciation, amortization, and restructuring or rent costs) and EBITDA (earnings before interest, taxes, depreciation, and amortization) are very similar metrics. The only difference is that with EBITDAR, restructuring or rental costs are also added back to net income.

Is EBITDAR the same thing as gross profit?

No. Gross profit is calculated by subtracting the cost of goods sold (COGS) from revenue. Unlike EBITDAR (earnings before interest, taxes, depreciation, amortization, and restructuring or rent costs), gross profit does not include non-production costs.

What is the formula for calculating EBITDAR?

To calculate EBITDAR (earnings before interest, taxes, depreciation, amortization, and restructuring or rent costs), you add certain non-recurring, non-operating, and non-cash expenses back to net income. The formula is: Net income + Interest + Taxes + Depreciation + Amortization + Restructuring/ Rental Costs = EBITDAR.

Photo credit: iStock/Inside Creative House

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

SOSMB-Q324-048

GAAP, an acronym for generally accepted accounting principles, is a set of rules and principles that public companies in the U.S. must follow when preparing their annual financial statements.

Without GAAP, it would be much more difficult for lenders, investors, and other interested parties to know how a business is performing.

Read on to learn more on what GAAP is, how it works, pros and cons of GAAP, the differences between GAAP and non-GAAP, and more.

What Is GAAP?

GAAP, or generally accepted accounting principles, is a commonly recognized set of rules and procedures designed to govern corporate accounting and financial reporting in the U.S.

GAAP was established to provide consistency in how financial statements are created, eliminate the potential for fraudulent or misleading financial reports, and make it easier for investors and creditors to evaluate companies and compare them apples-to-apples.

All publicly traded businesses in the U.S. must use GAAP in their financial statements. While small businesses that don’t get audited aren’t required to use GAAP, doing so can still be helpful, particularly if your business may be interested in attracting an investor or exploring small business loans at some point.

How GAAP Works

Three nonprofit organizations — the Financial Accounting Foundation (FAF), Financial Accounting Standards Board (FASB), and Governmental Accounting Standards Board (GASB) — play a role in setting GAAP standards as follows:

•  FAF oversees the FASB and GASB organizations

•  FASB issues GAAP rules for businesses and nonprofits

•  GASB issues GAAP standards for state and local governments

For businesses filing periodic reports with the U.S. Securities and Exchange Commission (SEC), GAAP dictates how a company can recognize revenue and expenses and how information needs to be presented to shareholders in an audited report. It also standardizes the financial reporting process so that third parties can easily compare and contrast two GAAP-compliant companies or entities.

GAAP incorporates three components to help eliminate misleading accounting and financial reporting practices:

•  10 accounting principles

•  Rules and standards issued by the FASB or GASB

•  Generally accepted industry practices

Why Is GAAP Important?

GAAP is crucial because it provides a standardized framework for financial reporting, ensuring consistency, accuracy, and transparency across businesses. This allows investors, regulators, and stakeholders to compare financial statements and make informed decisions. GAAP also helps maintain trust in the financial system by reducing the risk of fraud and misrepresentation.

Recommended: Guide to EBITDAR: What You Should Know

Pros and Cons of GAAP

GAAP offers a number of benefits. It guides companies in preparing accurate and clear financial data, reduces fraudulent financial reporting, and provides consistency in the financial statements of one GAAP-compliant company to another.

However, GAAP also has some limitations. Its “one-size-fits-all” approach to financial reporting, for example, doesn’t always address issues faced by specific industries. GAAP can also be overly complex, as well as costly to implement, for smaller businesses. And, it’s not a globally used standard, which can make it challenging for international organizations and for investors who want to compare companies operating in different countries.

Pros of GAAP

Here are some of the pros of GAAP:

•  Fosters honesty and transparency in financial reporting

•  Makes it easy to compare one GAAP-compliant company to another GAAP-compliant company

•  Ensures that businesses follow the same accounting principles for all reporting periods

•  Enables businesses to compare their performance with that of their competitors

Cons of GAAP

Here are some of the cons of GAAP:

•  Strict accounting model does not address many industry-specific situations

•  Can be costly for smaller companies to become GAAP-compliant

•  Overshadows non-U.S. GAAP financial performance metrics, such as adjusted EBITDA

•  Not a global standard

Recommended: What Is the Difference Between EBIT and EBITDA?

10 Important GAAP Principles

GAAP has 10 fundamental principles companies must follow:

1. Principle of Regularity

Accountants must adhere to the rules and regulations of GAAP accounting. This principle keeps accountants from making up their own methods. With GAAP, any accountant can understand the work of another accountant. This is extremely important when comparing businesses and analyzing their worth.

2. Principle of Consistency

Accountants must apply the same standards and techniques for all accounting periods. This ensures financial comparability between periods. Any changes or updated standards must be explained in the footnotes to the financial statements.

3. Principle of Sincerity

Accountants must be as honest, impartial, and accurate in their reporting of a company’s financial performance as possible. They cannot lie or fudge numbers to make a company seem more profitable.

4. Principle of Permanence of Methods

All GAAP-compliant companies must be consistent with their methods and procedures. By doing so, all GAAP-compliant companies can be compared regardless of their industry.

5. Principle of Non-Compensation

Businesses must report all aspects of their performance, both good and bad, and without the expectation of debt compensation.

6. Principle of Prudence

Accountants should never speculate or give their opinion in a financial report. All records must only include expenses and provisions for spending that have or will certainly take place.

7. Principle of Continuity

While valuing assets, accountants must assume the business will continue to operate in the foreseeable future. Any potential buyouts or foreclosures should not be considered.

8. Principle of Periodicity

Accountants must report all revenue and expenses in the appropriate accounting period, such as fiscal quarters or fiscal years.

9. Principle of Materiality

Accountants must strive to fully disclose all financial data and accounting information in financial reports.

10. Principle of Utmost Good Faith

All parties that contribute to a company’s financial report are assumed to be honest and reputable.

Recommended: Debt-to-EBITDA Ratio Explained

Alternatives to GAAP

IFRS

The International Financial Reporting Standards, or IFRS, are another set of accounting standards, but these are used at the international level. IFRS is standard in the European Union and many countries in Asia and South America, but not in the United States. IFRS was established so that companies could be comparable from country to country.

The main difference between GAAP vs. IFRS is that GAAP prioritizes rules and detailed guidelines, whereas IFRS only provides general principles to follow. Accountants have more leeway when following IFRS, but often need to include explanatory documents. On the other hand, businesses that use GAAP may feel confined by the lengthy rules.

Recommended: How to Calculate Cash Flow

Tax-Basis Accounting

Tax-basis accounting follows the accounting that a company is required to use for filing its federal tax return. If allowed by creditors, investors, and other financial statement users, tax-basis accounting can make sense for a privately held company, since it means less work when preparing the company’s tax return. When comparing tax-basis vs. GAAP accounting, tax-basis accounting is less complex and often leads to less footnote disclosures in financial statements.

GAAS

Generally accepted auditing standards, or GAAS, is the framework that guides auditors. GAAS standards help auditors prepare a transparent and reliable audit report on companies. Following these standards also ensures that auditors don’t miss any important information. When comparing them, it’s important to remember that GAAP is used by accountants, whereas GAAS is used by auditors. Therefore, an auditor following GAAS may see how well a company is following GAAP.

Recommended: Explaining GAAS vs GAAP

The Takeaway

GAAP is the set of accounting rules and principles that public U.S. companies must follow when putting together financial statements. The goal of GAAP is to hold publicly traded companies accountable and ensure their financial statements are complete, consistent, and comparable.

For small business accounting, you are not required to follow GAAP regulations. However, doing so can make it easier for outsiders to evaluate your business and compare it with other companies in your industry. Publishing GAAP-compliant financial statements could make it easier for your business to attract an investor or get approved for certain types of business loans.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

How many principles does GAAP have?

The generally accepted accounting principles, or GAAP, has ten principles. They are:

1.   Principle of regularity

2.   Principle of consistency

3.   Principle of sincerity

4.   Principle of permanence of methods

5.   Principle of non-compensation

6.   Principle of prudence

7.   Principle of continuity

8.   Principle of periodicity

9.   Principle of materiality

10.   Principle of utmost good faith

Is GAAP the same in every country?

No, only U.S. publicly traded companies must use GAAP (generally accepted accounting principles). IFRS (International Financial Reporting Standards) is used in the European Union and many countries in Asia and South America.

Why is GAAP important?

GAAP (generally accepted accounting principles) is important because it ensures honesty, transparency, and uniformity in financial reporting. Without GAAP standards, businesses could report their earnings differently, which could make it difficult for investors and creditors to evaluate and compare companies, and could also provide opportunities for fraud.

What does GAAP stand for?

GAAP is the acronym for generally accepted accounting principles, a comprehensive framework of accounting rules. GAAP is primarily used in corporate accounting and financial reporting in the United States.

Who oversees GAAP?

Three nonprofit organizations — the Financial Accounting Foundation (FAF), Financial Accounting Standards Board (FASB), and Governmental Accounting Standards Board (GASB) — play a role in setting GAAP standards. FAF oversees the FASB and GASB organizations, while FASB issues GAAP rules for businesses and nonprofits and GASB issues GAAP standards for state and local governments. The U.S. Securities and Exchange Commission (SEC) can establish GAAP via government regulations, but it typically allows the private sector to establish the standards.

Photo credit: iStock/AndreyPopov

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

SOSMB-Q324-047

A non-governmental organization (NGO) is an organization independent of the government that focuses on social, environmental, educational, and other issues. These organizations generally aim to make the world a better place, whether that’s the American Red Cross holding a blood drive or the World Wildlife Fund working to protect and restore species in their habitats.

But how do NGOs raise the kind of money they need to operate, which may be on the order of millions, or even billions, of dollars? It depends on the NGO, but here’s a look at some of the key sources of NGO funding.

What Is an NGO?

The acronym NGO stands for non-governmental organization. These groups function independently of any government but may be involved in national or international philanthropic, developmental, or social missions. For example, Doctors Without Borders is an NGO that provides medical assistance and access to medicines to those in need throughout the globe.

Though they are independent from the government, NGOs may receive funds from government agencies.

NGO Purpose

The purpose of an NGO is to promote positive change through advocacy, direct service, and awareness-building. Their activities can range from providing education, healthcare, and disaster relief to advancing human rights and environmental protection.

NGOs play a critical role in filling gaps left by government agencies, often focusing on areas like poverty alleviation, development, and public policy. They address challenges that governments or businesses may not prioritize, working on both local and global levels to create sustainable impact.

How Do NGOs Work?

NGOs are typically nonprofit entities organized by private citizens. These organizations can pursue a wide range of goals for social, developmental, or political purposes, and may operate on a local, national, or even international level.

As nonprofits, NGOs can accept donations from private individuals, for-profit companies, charitable foundations, and governments (local, state, federal, and foreign). They also raise funds by charging membership dues and selling goods and services.

NGOs vs. Nonprofits

While an NGO is a nonprofit, there are a few key differences between the two.

Key Differences

NGOs tend to operate on a much larger scale than nonprofits. They’re not concerned with only helping people in one city or community; instead, they often support national and international projects for causes such as disaster relief and human rights. Their budgets tend to be much larger than that of a local nonprofit, and therefore the funding needed by an NGO is typically significantly higher.

Both nonprofits and NGOs, however, rely on fundraising, donations, and grants to sustain operations.

Recommended: 11 Funding Sources for Nonprofits

How Do NGOs Get Funding?

While NGOs aren’t affiliated with any governmental agency, funds for NGOs often come from grants that are offered by local, state, and federal governments. Grants can also come from foreign governments.

NGOs may also accept private donations from individuals, charitable foundations, or corporations. They may also raise funds through sales, memberships, and fundraising campaigns.

Importance of Diverse Funding

Diverse funding is crucial for NGOs as it ensures financial stability and reduces reliance on a single source, minimizing the risk of disruptions if one funding stream dries up. Multiple funding sources, such as donations, grants, partnerships, and income-generating activities, allow NGOs to maintain independence and flexibility in their operations.

Fund Usage and Reporting

NGO fund usage is typically directed toward achieving the organization’s mission. This includes project implementation, operational costs, and capacity building. Funds are allocated for specific programs like education, healthcare, or environmental initiatives, as well as for staff salaries, administrative expenses, and outreach activities.

Transparent and accurate financial reporting is crucial for maintaining donor trust and accountability. NGOs are required to provide regular financial reports, detailing how funds are used and ensuring they align with donor expectations. This reporting may include annual audits, financial statements, and progress reports, which help donors and stakeholders assess the impact and effectiveness of the NGO’s work.

Recommended: How Do You Structure a 3-Year Business Plan?

6 NGO Funding Sources

Here are some of the ways an NGO may raise revenue to fund their operations and support their missions.

1. Grants

Often, a significant portion of the funds for NGO projects comes from grants offered by corporations, as well as local and federal governments. Unlike small business loans, grants for businesses, nonprofits, and NGOs don’t have to be repaid. Competition for these awards, however, tends to be stiff. Writing a grant proposal can also take a fair amount of time, effort, and expertise.

Pros:

•  Money doesn’t have to be repaid

•  NGO may be able to automatically qualify for the same loans year after year

•  Can be for large amounts

Cons:

•  Funding for grants can dry up

•  There may be heavy competition to qualify for certain grants

•  Requires a grant writer on the team to fill out applications

2. Fundraising

Just like other nonprofits, NGOs often engage in a variety of fundraising activities to help fund their operations and fulfill their missions. Fundraising efforts can range from offering a website donation link to hosting elaborate events like galas, festivals, and auctions. There’s no limit to the possibilities when it comes to fundraising. In fact, Doctors Without Borders even organizes charity video game marathons to help raise funds.

Pros:

•  Money doesn’t have to be repaid

•  Funds can come from any donor who’s interested in supporting the NGO

•  Fundraising activities provide a way to publicize an NGO and its cause

Cons:

•  Planning fundraising events can be time-consuming

•  Fundraising needs to be ongoing; it’s not a one-and-done event

•  May require finding businesses and individuals to donate time or products

Recommended: How to Set Up a Fundraising Bank Account

3. Private Donations

Funding from NGOs can also come from wealthy individuals who seek philanthropic activity. They may donate money annually or bequeath large sums in their wills upon their death.

Pros:

•  Money doesn’t have to be repaid

•  Donations can be sizable

•  For the donor, money given to NGO may be tax deductible

Cons:

•  Large donations aren’t guaranteed

•  Donors may want to be honored through a plaque in their name or a mention at an event

•  Donations may slow during sluggish economic times

4. Membership

Another way for NGOs to raise money is to charge for membership. To attract members, the NGO may offer exclusive benefits and perks. For example, PETA (People for the Ethical Treatment of Animals) offers members a subscription to its magazine, as well as a calendar, vegan recipes, and discounts on products.

Pros:

•  Money doesn’t have to be repaid

•  The perks offered to members are usually low-cost

•  Members feel more invested in helping the NGO

Cons:

•  Membership fees are typically low, so it takes a large number of members to raise significant funds

•  NGO needs a membership coordinator or department to run the program

•  Perks need to be enticing enough to draw members

5. Corporate Sponsorships

Just like private individuals, many corporations engage in philanthropy, and many do so by financially sponsoring NGOs. There are a variety of ways a corporation can sponsor an NGO, including direct donations, event partnerships, and matching gifts. This allows a corporation to give back, potentially get a tax deduction, and become affiliated with an NGO that has a powerful and positive mission.

Pros:

•  Corporate sponsorships can be of significant value

•  Partnering with a corporation can amplify the NGO’s message faster and further

•  Corporation may get tax benefits with the donation

Cons:

•  May require a dedicated individual or team to find corporate sponsorships and manage the relationships

•  Continual support from a corporation isn’t guaranteed

6. Business Loans

Like businesses, nonprofit organizations sometimes need cash in the form of a loan to operate their programs effectively. For example, an NGO may encounter a situation in which the timing of when they receive funds from grants and other sources and when they need to pay bills are out of sync. A cash flow loan or business line of credit can help bridge gaps in cash flow and enable an NGO to run efficiently.

Different types of small business loans can also make it possible for an NGO to take advantage of a time-sensitive opportunity or make costly but key capital improvements. Sometimes a grant or in-kind donation can fit the bill, but in many cases, a loan with monthly payments may be the best funding tool.

Pros:

•  Can be easier and faster to get than a grant, corporate gift, or large donation

•  Can enable an NGO to take advantage of a short-term opportunity

•  Can help an NGO make capital investments that will improve operational efficiency

Cons:

•  Money has to be repaid, plus interest

•  NGO will need to prove it has sufficient revenue to repay the loan and may need to provide collateral

•  Lenders may charge nonprofits a higher interest rate due to higher risk involved

Recommended: 6 Step Guide to Getting a Small Business Loan

The Takeaway

With budgets sometimes in the hundreds of millions, finding sources for funding projects, operations, salaries, and other overhead costs is typically an ongoing effort for NGOs.

As nonprofit organizations, NGOs often rely on a variety of funding sources, including membership dues, the sale of goods and services, grants from corporations and governments, fundraising activities, and private donations. Loans can also be a tool that can help an NGO grow and succeed.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

What does NGO stand for?

NGO stands for “non-governmental organization.” It refers to a nonprofit group that operates independently from government control, typically working to address social, environmental, humanitarian, or development issues.

What are some notable NGOs?

Some notable NGOs include Doctors Without Borders, The World Wildlife Fund, Amnesty International, Greenpeace, Make-A-Wish Foundation, Habitat for Humanity, and Red Cross.

Are NGOs and nonprofits identical?

No. While an NGO is a nonprofit, a nonprofit isn’t necessarily an NGO. NGOs tend to have a larger, more global reach than nonprofits.

Photo credit: iStock/metamorworks

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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