How MD&A Can Yield Better Investing Decisions
Management’s discussion and analysis (MD&A) is the narrative explanation of financial statements and other important operational data in a company’s annual report or quarterly filing. MD&A is critical to understanding a company’s reported financial results. Specifically, MD&A is the only section where management can discuss not only what happened, but also why it happened and whether the financial results are indicative of the future performance or financial condition of the company. This section affords management the opportunity to discuss the potential impact of current events and other risk factors. Management also uses MD&A to explain financial results at the segment level, consistent with how it views and operate the business.
For these reasons, the SEC continues to focus on MD&A, as evidenced by the number of comment letters that emphasize its requirements and objectives. Although the financial statements are the quantitative representation of the results of a company’s operations, management should not underestimate the importance of MD&A when preparing the disclosure document.
Despite the focus on MD&A, many companies face similar stumbling blocks as they draft the disclosure. Below are some common mistakes and considerations for how to avoid them.
- A successful MD&A enables investors and other readers to understand an entity through the perspective of its management and can help enhance the overall financial disclosure. The information discussed in MD&A often provides needed context for which financial information should be analyzed. For that reason, companies should highlight the themes and topics most relevant to financial statement users early in the disclosure.
- Avoid using the prior period disclosure as a starting point. A common but ineffective practice is to provide period over period changes in certain financial metrics that can otherwise be gleaned from the financial statements, along with some accompanying narrative. Specifically, for companies in mature industries, the tendency is to simply update the numbers instead of starting from scratch. This minimalist approach has become increasingly less effective in the current economic climate, which is impacted at all levels by both broad economic and political conditions as well as more local, regional factors.
- Call attention to any trends or uncertainties that are likely to have a material effect. While this approach may seem obvious given the MD&A objectives, companies can fall into the aforementioned trap of simply updating boilerplate language or, more commonly, not providing sufficient disclosure or information surrounding such events. Further, if information is reasonably available, quantification of the effects of these items is expected and, for public companies, can be required.
- When deciding to include trend disclosure, be aware that this inclusion may result in the need to address this same trend in future MD&A rather than removing the disclosure altogether. Similarly, if trend disclosures have been included in the past, consider whether they continue to be relevant or need to be updated in the current disclosure.
- Ensure that information included within MD&A is consistent with other public disclosures like press releases, website information, and analyst calls. While adopting a process to promote consistency in matters covered across such disclosures is helpful, companies should also ensure that the level of disclosure within MD&A is appropriate as compared to the other disclosure, taking into account the materiality and importance of the matter.
- When formulating disclosures, be mindful of current events. Interest rates, tariffs, or changing economic policies could have an impact on financial performance and should be acknowledged in the stated risk factors, to the extent they are material. Remember that a uniform approach is not required for addressing risk factors; each company must determine the importance or materiality to their disclosure.
- Keep in mind that MD&A is management’s opportunity to put context around a company’s financial results. Use plain English and supplement heavily quantitative disclosures with illustrative tables and charts.
SEC Comment Letter Trends
For public companies, the SEC continues to focus on MD&A. Recently, three specific areas have garnered the most significant attention, resulting in comment letters to registrants:
- Results of Operations: Recent comment letters have stressed the need for clearer description and quantification of unusual or infrequent events or significant economic changes. Registrants should be mindful to not just highlight fluctuations but also elaborate on the underlying reasons for them.
- Critical Accounting Estimates: Comment letters have focused on the judgements made by registrants in the application of significant accounting policies and what the likelihood is of materially different reported results if different assumptions or conditions were to prevail.
- Liquidity and Capital Resources: The SEC has emphasized the need for a clear discussion on the drivers of cash flows and the trends and uncertainties related to meeting known or reasonably likely future cash requirements.
Recently Adopted SEC Amendments
In order to simplify and modernize reporting requirements of public companies by improving disclosure effectiveness and reducing compliance costs, the SEC amended its rules in March 2019. Several of these amendments impact the SEC’s MD&A requirements.
Specifically, registrants may now exclude discussion of the earliest of the three reported years in MD&A if that year was discussed in previous filings; however, if information of that period is material, it should be included. Additionally, registrants are no longer required to compare financial statement line items with the previous year within MD&A, allowing each year to be discussed individually.
By focusing on delivering against the stated objectives of MD&A—specifically including clear, updated, consistent, and detailed information—companies will enable users of financial statements to make more informed investing decisions. Efforts to simplify reporting will help registrants to improve disclosures while reducing the cost of compliance.
Riveron’s accounting advisory specialists can help management articulate the “why” within MD&A by developing and structuring the content, performing period-to-period fluctuation analyses, gathering disclosure support, and establishing templates and reporting tools for ongoing SEC reporting.
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