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Building a better MD&A

By Chris Hicks

Management’s Discussion and Analysis (MD&A) is now generally recognized as a core document in both the interim and annual financial reporting of public companies. This is due to a number of factors, including demand from investors, strengthening of the securities regulators’ rules for MD&A, and the requirements for the CEO and CFO “material fact” and “fairly present” certifications.

Notwithstanding that MD&A is now part of the core reporting package, some companies take a minimalist view to its prep-aration, barely complying with regulatory requirements. This is shortsighted. Good MD&A provides key insights into the business and its prospects and helps investors interpret the financial statements and understand the extent to which past results might be indicative of future performance. In this way, they differentiate the company from its competition and act as an investor relations tool rather than merely a regulatory requirement. Good MD&A may lower a company’s cost of capital by communicating information that helps capital providers come to a more informed and reliable judgment about the value of the business.

Over the past several years, CICA’s Canadian Performance Reporting Board has been helping to raise the standard for MD&A. It has developed principles and a framework for preparing MD&A in its publication Management’s Discussion and Analysis: Guidance on Preparation and Disclosure, available through CICA’s MD&A Resource Centre at www.cica.ca/mda.

The CICA guidance, which complements the securities regulators’ detailed MD&A reporting rules in National Instrument 51-102, sets out six principles to follow when preparing MD&A:

Information in the MD&A should enable readers to view the company through the eyes of management.
MD&A should complement and supplement financial statements — it should provide useful quantitative and qualitative information about the business and its performance that is not reported in the financial statements and should explain the conditions and events that shaped the results in the financial statements.
MD&A should be complete, fair and balanced and provide information that is material to the decision-making needs of users.
MD&A should have a forward-looking orientation.
MD&A should focus on management’s strategy for generating value over time.
MD&A should be written in plain language, with candour and without exaggeration, and should embody the qualities of understandability, relevance, comparability and consistency over reporting periods.

The first three of the above-noted principles are clearly embodied in NI 51-102, while the last three are less evident.

CICA’s guidance then provides 27 recommended practices in an MD&A disclosure framework organized within five key elements that can be expressed as follows:

Applying the CICA principles and framework in addition to complying with the securities regulators’ rules will help produce a better MD&A. Noted below are some particular points to bear in mind, based on reviews of recent MD&As and discussions with regulators, investors and managements:

The MD&A should be well-organized and easy to read. It is helpful to provide a table of contents and executive summary. In a company with several segments, it is often useful to prepare a mini MD&A for each segment.
MD&A should not repeat financial statement items but should provide additional interpretive information. This may in- clude, for example, discussions about margins and cost structures, and information about nonoperational matters such as emerging contingent liabilities and pension plan liabilities.
The MD&A should discuss those key performance drivers in which superior performance and favourable results are essential for the company. As well, the related performance indicators that management uses to monitor the business should be reported and discussed. Trends should be presented, and are often best illustrated through charts and tables.
Although MD&A presents the view of the company through management’s eyes, MD&A nevertheless needs to be balanced, reporting negative as well as positive factors.
Discussions of human resource capabilities should include not only information about special workforce skills and strengths but also about management — for example a review of management changes and performance evaluation criteria that relate to executive compensation.
Whenever possible, MD&A should present forward-looking information, provided there is a reasonable basis for making the statement and provided appropriate caveats are included about factors that might influence its achievement. Some companies are reluctant to provide forward-looking information for fear of losing a competitive advantage or because of concerns about legal liability. On the other hand, if customers, employees or competitors already know about an initiative, the issue is already public knowledge and accordingly could be required disclosure to meet the regulators’ “material fact” or “fairly present” tests. In this regard, it should be noted that forward-looking information may take various forms, including information that will enable analysts to estimate future growth, such as a description of potential future projects, the status of sales orders, or percentage of completion of a new operating facility.
MD&A should avoid disclosing irrelevant information. Discussion of risk, for example, should comprise the critical risks that occupy management and the board, together with the strategies and processes in place to manage those risks, not a laundry list of all risks to which the entity may conceivably be exposed. As well, the MD&A should discuss and quantify the entity’s sensitivity to its critical risks.
MD&A should discuss future goals and associated rationale and results should be linked to previously established targets.
A comprehensive interim MD&A is an important vehicle for explaining progress towards previously disclosed targets and plans to rectify situations where targets are not being met. Accordingly, the annual MD&A should be revisited at each quarter end to determine whether any significant events have occurred that impact achievement of the annual plan.

Now is a good time to be thinking about building a better MD&A. In addition to the above-noted CICA MD&A guidance, CICA’s MD&A Resource Centre provides other useful materials, including a self-assessment checklist and examples of various MD&A disclosures set out under the main headings of the CICA guidance. As well, the securities regulators periodically publish reports of major deficiencies they have found in their reviews of MD&A.

Chris Hicks, CA is principal, Knowledge Development, at CICA

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