What is MD&A (Management Discussion and Analysis)?
MD&A or Management Discussion and Analysis is the part of financial statements where the company’s management discuss the company’s performance in the current year using qualitative and quantitative measures to help the investor in realizing the details that which otherwise would not have been available for analysis. The MD&A section includes various topics including the Macro-Economic Performance of the industry, the Company’s Vision and Strategy and some key financial indicators and their rationale.
As an investor, that is very insightful information provided by a company to co-relate macroeconomic parameters and the performance of the company in light of them. The section containing Management Discussion and Analysis is included in companies’ annual reports in addition to a similar section analyzing the company’s performance and decoding the financial ratiosFinancial RatiosFinancial ratios are indications of a company's financial performance. There are several forms of financial ratios that indicate the company's results, financial risks, and operational efficiency, such as the liquidity ratio, asset turnover ratio, operating profitability ratios, business risk ratios, financial risk ratio, stability ratios, and so on. and various indicators for the investors.
What details must You look at in MD&A?
The corporate world has adopted the MD&A route to demonstrate their commitment to the Company’s vision and strategy, and how the management has created value and delivered a performance in light of their long term goals. When the term management is referred throughout this topic, it will be involving complete structure of organization including the Board of Directors, Chief Executive Officer and other Chiefs, their reporting officers/controllers of various departments – Human Resources (People), Finance, Marketing, Production, and Operations, etc and the remaining middle and lower management levels. Hence, MD&A does not only dissect financial figures/results but also looks into the Human resources and operations side of the business, which the fundamental and key factors to any business organization.
# 1 – Executive Overview and Outlook
Executive Overview and Outlook section focus on details of the business, number of segments and geographies that they operate. It also provides details on the focus areas of the management and how they look forward to achieving the business and financial accounting objectives.
source: Colgate SEC Filings
- Colgate uses a variety of indicators to measure business health. These include market share, net sales, organic growth, profit marginsProfit MarginsProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. , GAAP and Non- GAAP income, cash flows and return on capital.
- Colgate also notes that it expects global macroeconomic and market conditions to remain highly challenging and category growth rates continuing to be slow.
# 2 – Discussion on Results of Operations
In this section, the company discusses key Highlights of the current fiscal period’s financial performance. In this, the management provides details of net Sales, Gross margins, Selling General and Admin CostsSelling General And Admin CostsSelling, general and administrative (SG&A) expense includes all the expenses incurred in the selling of the products of the company whether direct or indirect along with the entire general and the administrative expenses during an accounting period under consideration such as advertisement expenses, sales promotion expenses, marketing salaries, etc., Income taxes, etc. Also, it provides details of any Dividend declaredDividend DeclaredDividend declared is that portion of profits earned that the company’s board of directors decides to pay off as dividends to the shareholders of such company in return to the investment done by the shareholders through the purchase of the company’s securities. and its payment details.
source: Colgate SEC Filings
- Colgate’s Net Sales were down 5% in 2016 as compared to 2015 due to a volume decline of 3% and a negative foreign exchange impact of 4.5%.
- Colgate notes that Organic sales of Oral, Personal and Home Care product segment increased 4$ in 2016.
# 3 – Discussion of Segment Results
The company also provides details of its individual segment, its contribution to the overall sales, growth rates and other performance measures.
source: Colgate SEC Filings
Colgate operates in over 200 countries with primarily two segments – Oral, Personal and Home Care; and Pet Nutrition segment.
# 4 – Non – GAAP Financial Measure
Generally, the company uses Non-GAAP measures for internal budgeting, segment evaluation, and understanding overall performances. Therefore the management shares this information with the shareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company's total shares. so that they can get better insights into the financial performance of the Company.
source: Colgate SEC Filings
The above table provides a reconciliationReconciliationReconciliation is the process of comparing account balances to identify any financial inconsistencies, discrepancies, omissions, or even fraud. At the end of any accounting period, reconciliation involves matching balances and ensuring that debits (credits) from one account for one transaction is same as the credit (debits) to another account for the same transaction. of Net Sales Growth (GAAP) to Non-GAAP measures for Colgate.
# 5 – Liquidity and Capital Resources
This section provides details of cash flow debt issuances that will help meet the business operating and recurring cash needs.
source: Colgate SEC Filings
Colgate generated a Cash Flow from OperationsCash Flow From OperationsCash flow from Operations is the first of the three parts of the cash flow statement that shows the cash inflows and outflows from core operating business in an accounting year. Operating Activities includes cash received from Sales, cash expenses paid for direct costs as well as payment is done for funding working capital. of $3,141 million in 2016 and its cash flow from investing activitiesCash Flow From Investing ActivitiesCash flow from investing activities refer to the money acquired or spent on the purchase or disposal of the fixed assets (both tangible and intangible) for the business purpose. For instance, the purchase of land and joint venture investment is cash outflow, while equipment sale is a cash inflow. was $499 million. Additionally, cash flow from Financing ActivitiesCash Flow From Financing ActivitiesCash flow from financing activities refers to inflow and the outflow of cash from the financing activities like change in capital from securities like equity or preference shares, issuing debt, debentures or repayment of a debt, payment of dividend or interest on securities. was an outgo of $2,233 million in 2016.
Additionally, Long-term debt, including the current portion, decreased to $6,520 in 2016
# 6 – Off-Balance Sheet Arrangements
This section provides details of any off-balance sheetDetails Of Any Off-balance SheetOff-balance sheet items are those assets that are not directly owned by the business and therefore do not appear in the basic format of the balance sheet. However, they tend to impact the financials of the company indirectly. financing arrangements if the company has entered into.
As we note from above, Colgate does not have any off-balance sheet financing arrangements.
# 7 – Managing Foreign Currency, Interest Rate, Commodity Prices and Credit Risk Exposure
In this section, the company discloses how it manages its currency risk, interest rate risksInterest Rate RisksThe risk of an asset's value changing due to interest rate volatility is known as interest rate risk. It either makes the security non-competitive or makes it more valuable. , and price fluctuations.
source: Colgate SEC Filings
- Colgate manages its foreign currency exposures through cost-containment measures, sourcing strategies, selling price increases and the hedgingHedgingHedging is a type of investment that works like insurance and protects you from any financial losses. Hedging is achieved by taking the opposing position in the market. of certain costs to minimize the impact on earnings of foreign currency rate movements
- The Company manages its mix of fixed and floating-rate debt against its target with debt issuances and by entering into interest rate swaps in order to mitigate fluctuations in earnings and cash flowsCash FlowsCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. that may result from the interest rate volatility.
- Futures contracts are used on a limited basis to manage volatility related to anticipated raw material inventoryRaw Material InventoryRaw materials inventory is the cost of products in the inventory of the company which has not been used for finished products and work in progress inventory. Raw material inventory is part of inventory cost which is reported under current assets on the balance sheet. purchases of commodities.
# 8 – Critical Accounting Policies and Use of Estimates
In this section, the company management discusses critical accounting policiesCritical Accounting PoliciesAccounting policies refer to the framework or procedure followed by the management for bookkeeping and preparation of the financial statements. It involves accounting methods and practices determined at the corporate level. that have a meaningful impact on the financial representation of the company’s health.
source: Colgate SEC Filings
As we note from above, Colgate uses both FIFO as well as the LIFO method for inventory valuationInventory Valuation Inventory Valuation Methods refers to the methodology (LIFO, FIFO, or a weighted average) used to value the company's inventories, which has an impact on the cost of goods sold as well as ending inventory, and thus has a financial impact on the company's bottom-line numbers and cash flow situation..
From the above-mentioned details, a fair idea can be taken have to what kind of information and disclosures today’s corporate world is required to make them accountable to the investors’ community and society at large as well as transparency in the reporting. Since the management is well positioned than the stakeholders who are the outsiders to provide information regarding the performance of the Company, based on such management’s analysis only certain present actions were taken by the Company can be justified and a walk towards their committed goals can be demonstrated by the management.
How does it help?
MD&A helps in understanding the operational and financial results in a better light. MD&A has certain definite objectives, which are as follows:
- Enabling the readers of the financial statements to understand in a better way the numbers, financial condition and to get into management’s shoes to understand certain strategic and operational decisions that are bold and largely impacting the future performance and position of the Company.
- Additional supplementary/complementary information provided in MD&A will help readers understand what exactly the financial statements depict and what is not reflected.
- Addressing the investors’ perception of the risks associated with the business operationsBusiness OperationsBusiness operations refer to all those activities that the employees undertake within an organizational setup daily to produce goods and services for accomplishing the company's goals like profit generation. and outlining past trends to indicate the management’s efforts towards mitigating those risks and leading the path towards future financial statements.
- There might be certain information, which though not mandated to be disclosed in the financial statements, its additional reference, and disclosure by the management can be of added value for the informed decision making by the stakeholders, which include Government authorities.
Government authorities, ranging from the Taxation authorities to capital market watchdogs to fiscal policyFiscal PolicyFiscal policy is a government policy that is used to control a country's finances and revenue, and it includes various taxes on goods, services, and individuals, i.e., revenue collection. It has an impact on spending levels, so it is referred to as monetary policy's sister policy. makers to banking regulators, etc., try to formulate the operational, fiscal and monetary policies not only based on the quantitative information provided by the Corporate through financial statements, but also based on the qualitative information mentioned in the Management Analysis section on the economy and the industry performance and their future goals.
What serves as objectives of MD&A is the benefiting factor to the stakeholder community. First-time investors in the equity marketsThe Equity MarketsAn equity market is a platform that enables the companies to issue their securities to the investors; it also facilitates the further exchange of these stocks between the buyers and sellers. It comprises various stock exchanges like New York Stock Exchange (NYSE). can adopt qualitative and informed decision making based on the information provided by the company’s management in their annual reports.
Format and Extent of information that MD&A should reveal:
As you can note from the above-mentioned objectives and governing regulations in India, there is a prescribed and constantly followed a practice of how the information is presented in the annual reportAnnual ReportAn annual report is a document that a corporation publishes for its internal and external stakeholders to describe the company's performance, financial information, and disclosures related to its operations. Over time, these reports have become legal and regulatory requirements.. However, neither is there any comprehensive reporting format prescribed by the Government in this regard nor can we notice any universal practice of disclosing such information among various companies from various industries or various countries. Hence, the accounting professionals and the governing institutions acting in the respective countries might provide guidance for the presentation of MD&A.
For example, Federal Accounting Standards Advisory Board (FASAB) in the United States has issued a recommended accounting standard on the Management Discussion and Analysis with the first draft published in January 1997, which can be accessed using the following link – FASAB standard on MD&A. In India, there is no standard or guidance note in this behalf, however, the Institute of Company Secretaries of India (ICSI) has issued Reference Note on Board’s Report under their Companies Act 2013 series, but leaving MD&A presentation to the interpretation of the industry.
So, taking the FASAB standard for our understanding purpose, MD&A should address the following:
- The entity’s mission and organizational structure;
- The entity’s performance goals and results;
- The entity’s financial statements;
- The entity’s systems, controls, and legal compliance; and
- The future effects on the entity of existing, currently-known demands, risks, uncertainties, events, conditions and trends.
Taking a note from another prominent institution’s guidance on Management Discussion and Analysis (originally published in November 2002), the Canadian Performance Reporting Board has laid down certain principles based on which MD&A should be prepared. Those principles are as follows:
- Through the Eyes of Management: A company should disclose information in the MD&A that enables readers to view it through the eyes of management.
- Integration with Financial Statements: MD&A should complement, as well as a supplement, the financial statements.
- Completeness and Materiality: MD&A should be balanced, complete and fair as well as provide information that is material to the decision-making needs of users. FASAB has described this requirement in other words, saying MD&A should deal with the “vital few” matters.
- Forward-Looking Orientation: A forward-looking orientation is fundamental to useful MD&A reporting.
- Strategic Perspective: The MD&A should explain management’s strategy for achieving short-term and long-term objectives.
- Usefulness: To be useful, MD&A should be understandable, relevant, comparable, verifiable and timely.
Consolidating what we have learned till now, let it be FASAB in the USA or Canadian Performance Reporting Board in Canada or ICSI in India, every governing agency have tried to foster the stakeholder’s informed decision-making function by providing guidance to the corporate world on how the investors can step up and look the situations from the management’s point of view. A good corporate governance practice exercised by a company will always try to improve its information dissemination function to improve its relations with various stakeholders and the society at large.
Differences Between MD&A & Audited Financials
As per SEC, an independent accounting firm should perform an annual audit of a company’s financial statementsCompany's Financial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels. and provide an opinion on any material misrepresentations. However, auditorsAuditorsAn auditor is a professional appointed by an enterprise for an independent analysis of their accounting records and financial statements. An auditor issues a report about the accuracy and reliability of financial statements based on the country's local operating laws. are not required to audit the Management Discussion and Analysis section. MD&A section in SEC FilingsSEC FilingsSEC filings are formal documents submitted to the Securities and Exchange Commission in the United States that contain financial information about the company as well as any other relevant information about recent or upcoming activities. are the opinions of the management about the company’s financial and business health and provide details of its future operations.
In light of increased participation of retail as well as foreign investors in the capital marketCapital MarketA capital market is a place where buyers and sellers interact and trade financial securities such as debentures, stocks, debt instruments, bonds, and derivative instruments such as futures, options, swaps, and exchange-traded funds (ETFs). There are two kinds of markets: primary markets and secondary markets. in recent years, a more comprehensive and transparent mechanism of information dissemination is always required. This is because MD&A must provide insightful and sufficient information to the stakeholder-community to analyze companies based on their performance and help better mobilization of the capital. This is more required in India, especially after the Economic Survey of 2017 depicts India as the beckoning sweet spot in the darkness of the world economy.
MD&A is being one of the very efficient ways to provide meaningful and highly useful information to the investors. Any improvements in MD&A and its presentation, the format will lead to good corporate governance practice and a healthy relationship between companies and the investor-community.