Elements of MD&A Disclosure Framework
Elements/ Factors of MD&A Disclosure Framework
Any corporate entity shall ensure to factor all of the following elements, while framing MD&A section of their annual reports.
Core Business and existence instinct –
Any investing decision taken requires understanding of the core business of an organization and its purpose. This gives close view of the business segments and products operated by the Company and to understand its risk-return profile. It’s obvious that without knowing the underlying business products and structure, one will not be able to value the firm fairly. Also, it is important to present management’s strategies, plans and near term proposed actions to help investors understand the trends and threats to the business.
Key Performance Drivers –
Since dynamic environment surrounding the business operations affects the business functions and indirectly, the financial performance barometers. To help better understand the causes-effect relationship, the management needs to provide extensive details on the key performance drivers which in turn affect the strategy formulation and its implementation, and hence, requiring continuous monitoring. These drivers might of financial or non- financial nature.
I would like to throw a focus on the difference between an indicator and a driver. We will take financial terms only for this learning purpose. Gross margin, i.e., Cost of goods sold divided by Total Sales, is an indicator which is a number based on certain economic activities (activities in the form of production of goods and subsequent selling of them) undertaken by the enterprise. Number of goods produced and sold per hour is a driver, which derives/ generates the margin to the enterprise.
So what can be interpreted from this? Driver is what is underlying at the bottom of the business and which in fact generates revenue or profit or results in expenditures. While indicator on the other side is a reflection of what has happened and remained after the above drivers were operating in their normal course of business.
Capability to deliver results –
The management demonstrates its capabilities to deliver results by justifying the working capital arrangements, assets base, geographical structure and reach. Relating these underlying assets to the financial indicators can provide more clear picture to the investors and can also provide the growth opportunity indications.
Results and Outlook –
With the complete management and operation of the business in the hands of the Board of Directors, the managements are well positioned to provide the insightful explanation for the running trends, resource utilization and forecasts.
Every industry and a company carries specific risks, arising from the general economic activities (driven by external environmental factors) and from certain internal reasons. Risk assessment and management, including data and cyber security, mechanism deployed in the organization by the management helps stakeholders to understand the risk profile of the company and that of the industry, and thereby, to take factor in such factors considering their impact on results and performance in present and longer term horizon.
Taking an example from the largest software provider firm of India.
When the corporate governance is at its peak, investors recall Tata group entities for their solid and committed corporate governance practice. Tata Consultancy Services (TCS), the crown jewel in the Tata group, has shown leader’s quality in establishing how MD&A can be used by a company to connect with the investors for enhanced trust and confidence. I have tried analyzing MD&A clause in the Annual Report of TCS for the fiscal period ended on March 31, 2019. MD&A has been started with a view on Macro Economy of India as well as the condition of world economy. On this backdrop, investors can analyze the operational and financial performance in realistic manner-
- Gradually stepping down from Economy to Industry and then to the Company specific level, Top-Down approach can provide better understanding of micro level indicators, based on the macro level conditions.
- The management has then given a clear picture on the Company’s longer term goals and strategy for short and medium term. After discussing the operational aspects of the Company, namely the technological developments and innovations, the discussion has been shifted to yet another important element of the business operations – Human Resources. Giving various aspects of the policies and efforts taken for talent development and retention were also discussed to highlight the commitment towards the People factor of an organization.
- Discussing on the risk management and the Company’s efforts on cyber security, an investor can interpret and understand the compliance model of the Company and management’s approach to the risks and security related concerns.
- Financial data has been represented using various graphical ways to provide better understanding of the underlying financial result for the given fiscal. Financial results have been presented by dissecting important elements such as revenues, assets, expenditures to provide analytical capabilities to the investors / stakeholders to interpret the results from various perspectives. There has been a separate table on the ratio analysis where investors can co-relate various variables and get a better picture of the financial position of the Company. In overall, this exercise has used past data to understand the present and help to depict the future capabilities.
Final Thoughts on MD&A
In light of increased participation of retail as well as foreign investors in the capital market in the recent years, especially when the Economic Survey of 2019 depicts India as the beckoning sweet spot in the darkness of world economy, a more comprehensive and transparent mechanism of information dissemination is always required to provide insightful and sufficient information to the stakeholders community to analyze companies based on their performance and help better mobilization of the capital. MD&A is being one of very efficient way to provide meaningful and highly useful information to the investors. Any improvements in MD&A and its presentation, format will lead to good corporate governance practice and healthy investors’ relationship.
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