Introduction to Management Discussion and Analysis
Management Discussion and Analysis (also known as MD&A) is a report to be included in the annual / periodical financial reports of public companies as mandated by the Securities and Exchange Commission (SEC) and through which the management of the company give comments on the financial statements, regulatory compliance, effectiveness of the internal controls and systems as well as actions to be taken for the future goals of the company.
Explanation
- This is a section contained in the annual report (SEC filing 10K) of the public companies wherein the management presents its points / analysis on the various matters such as regulations, performance, internal control system, etc. on the basis of qualitative & quantitative measures.
- MD&A is required to be given in annual reports as well as quarterly filing reports since, it gives an edge in the understanding of the financial statements by the end users (or stakeholders). It is made to be compulsorily by US SEC and to be given by the management of the public companies.
- MD&A summarises the position at past, position in the current environment & future projections as well.
Example of Management Discussion and Analysis
We take example of “Domino’s Pizza, Inc” which filed its Form 10K for the fiscal year 2019. The item number 7 of the form is “Management Discussion and Analysis” explained in around 13 pages. Let’s summarise few points out of those 13 pages:
(source:https://www.sec.gov/ix?doc=/Archives/edgar/data/1286681/000119312520042675/d796357d10k.htm)
- Operations are discussed in comparison to fiscal year 2018. Also, Part II of item 7 includes comparison of fiscal year 2018 with fiscal year 2017.
- Short description of the business is provided wherein the management specifies its location around the globe, its products, business model, product delivery mechanism, operation mechanism of franchisees,
- Some of the highlights of fiscal year 2019 compared to 2018 are increase in global retail sales by 8%, increase in revenue by 5%, increase in the income from operations by 10%, increase in net income by 11%, increase in number of stores by 1106 and increase in diluted earnings per share (DEPS) by 14%.
- Further the item 7 specifies its critical accounting policies such as revenue recognition, long-lived assets, insurance & legal matters, share based payments, etc.
- The report also specifies increase in store-wise revenue, store-wise operating margins and supply chain operating margin.
- It also highlights on the cashflow statement in a summarised manner.
What is Included in Management Discussion and Analysis?
- MD&A is the most desirable section of the whole annual report since it summarises all points from all corners of the entity. It also specifies the factors of growth.
- Annual report is around 100-pages while the section of MD&A summaries the operational facts, margins, business model, history, etc. in mostly 13-15 pages.
- It also highlights the future goals of the organisation & also specifies the current steps taken to achieve the future goals. Thus, financial analysts review the MD&A section in a very detailed manner to understand the fundamental aspects of the entity.
- The financial statement is audited by external party but the MD&A section is unaudited part of the annual report. However, the MD&A has facts which will match with figures in the entire annual report. So, sufficient reliance can be placed.
- Besides what we explained in the example above, MD&A section also provides information about the regulatory compliance by the entity, existence of internal control system & operating effectiveness of the same, and further plans of the organisation to expand surpassing the existing problems.
Requirement of Management Discussion and Analysis
- The requirement of the section for Management Discussion & Analysis is required by the US Securities and Exchange Commission (SEC) & also by the Financial Accounting Standards Board (FASB). At present, it has to be included in the annual reports of the public companies only.
- The purpose is to let the management provide a balanced view of the future prospects of the entity. This helps the stakeholders understand the fundamentals of the company & the approach of the management in dealing with any issues.
- Though the MD&A section is unaudited, the FASB requires the management to states the positive as well as negative aspects/ facts in respect of the entity in an independent manner.
- This further helps in the transparent conduct of business activities.
Key Aspects of Management Discussion and Analysis
Management Discussion & Analysis sections deals in many aspects of the entity. Yet there are a few key aspects which has its own importance. Few are described below:
1. Highlights about the Current Fiscal Year
- Highlights give summarised important facts as compared to last year.
- This area shows the growth aspect, earnings aspect, business model aspect of the entity through financial figures.
- It gives a small picture of enormous transaction of the business.
2. Critical Accounting Policies & Estimates
- This aspect covers the important accounting policies & estimates which has major impact on the results of the entity.
- This area explains how the estimates & judgements made by the management affect the reported amounts of revenue, expenses, assets, liabilities and various disclosures. It also explains the scientific method used for making the estimates.
- Few of the critical accounting policies includes revenue recognition, share-based payments, income taxes, long-lived assets and many more.
- This explains the readers about how the picture of financials can change with the change in few methods of estimates & assumptions.
- This helps the readers get a complete understanding about the most critical accounting policies having major impact on the performance evaluation of the company.
3. Liquidity & Capital Resources
- This area highlights the liquidity issues & position of the company.
- It specifies the commitments, possible uncertainties of the business claims, etc. which will have impact on the capital resources. The management should identity the areas of capital expenditure.
- This should give hints about the future funding plans of the management including any changes which are required in the current capital structure of the entity.
4. Results of Operations
- This should give highlights of the results of the operations. This area should also highlight any unusual economic activities that bear impact on the continuing operations of the entity.
- MD&A also explains the events that have credible impact on the net earnings, revenues and gross profit of the entity.
- The management should also explain the attributes or facts for any unusual movement in the figures contained in the financials. For example, in case of rise in cost of goods sold (COGS), the management should provide facts such rise in material cost, increase in labour turnover, excess cost incurred in the production chain, etc.
The management discussion and analysis section presents the whole picture in a transparent manner. This helps the stakeholders to independently analyse the things without any favourable bias. The end purpose of increasing the understanding of the readers of annual report, is also served. Management discussion and analysis helps providing useful information & uplifts the compliance mechanism of the federal government.
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