Management’s discussion and analysis is part of the disclosures section of the financial statements, in which prior period performance and projected results are discussed. This is one of the most closely reviewed parts of the financial statements, since a reader can interpret from it the opinions of management regarding the performance and future prospects of a business.
The MD&A section is a required part of the quarterly and annual financial reports of publicly-held companies, being mandated by the Securities & Exchange Commission (SEC). It is not a required part of the financial statements of privately-held entities.
The SEC requires that the MD&A section describe opportunities, challenges, risks, trends, future plans, and key performance indicators, as well as changes in revenues, the cost of goods sold, other expenses, assets, and liabilities. These requirements are based on three SEC objectives related to financial reporting, which are:
- To give a narrative explanation of the financial statements from the perspective of management
- To enhance the numerical disclosures in the financial statements, as well as to provide a context within which to review this information
- To discuss the quality and possible variability of an entity’s earnings and cash flows
The MD&A section is a clear favorite of the SEC for critiques. The SEC staff wants to see interpretive comments from a company regarding the results of operations, rather than a dry recitation of the percentages by which revenues and expenses changed in the past year, with boilerplate reasoning given for changes in performance.
When a company conducts earnings calls with the investment community, it should maintain a record of the questions asked, and see if any of them could have been addressed within the MD&A section of its financial statements. This can form the basis for an increased amount of MD&A material in the next set of financials.