Management Discussion and Analysis (MD&A): Definition and Example

What Is Management Discussion and Analysis (MD&A)?

Management discussion and analysis (MD&A) is a section of a public company's annual report or quarterly filing. The MD&A addresses the company's performance for the reporting period. In this section, the company's management and executives, also known as the C-suite, present an analysis of the company's performance with qualitative and quantitative measures.

Understanding Management Discussion and Analysis (MD&A)

A company's management uses the MD&A section of its annual report to provide commentary on financial statements, systems and controls, compliance with laws and regulations, and actions it has planned or taken to address any challenges the company is facing. Management also discusses the upcoming year by outlining goals and approaches to new projects.

The MD&A is an important source of information for analysts and investors who want to review the company's financial fundamentals and management performance. It is just one of many sections required by the Securities and Exchange Commission (SEC) and the Financial Accounting Standards Board (FASB) to be included in a public company's annual report to shareholders.

The SEC, which oversees public companies' compliance with U.S. securities laws and ensures investors are given adequate information about companies they invest in, mandates 14 items to be included in the 10-K report. The MD&A section is Item #7. The FASB outlines its requirements for the MD&A section of filings.

Requirements for Management Discussion and Analysis (MD&A)

Securities law dictates that companies must hire an independent auditor to verify their financial statements, such as their balance sheet, income statement, and statement of cash flows.

While auditors (generally certified public accountants) determine if the financial statements are materially accurate, they do not audit Management's Discussion and Analysis (MD&A) section. The MD&A represents the thoughts and opinions of management and provides a forecast of future operations. Therefore, these statements can't typically be authenticated.

The MD&A section must meet certain standards. According to the FASB, "MD&A should provide a balanced presentation that includes both positive and negative information about these topics."

Even if management gives its opinions on the state of its business, competition, and risks, these statements must be rooted in facts, and there must be an attempt to paint a balanced picture of the company's prospects.

What's Covered in Management Discussion and Analysis (MD&A)?

The MD&A section often includes a section for the management's overview and outlook. This part of the financial statement explains what the future of the organization looks like. It is also management's opportunity to explain why variances (positive and negative) occurred and what they expect from the market.

Next, management also typically discusses liquidity, solvency, and capital resources. Management must identify trends, demands, or long-term commitments that may strain capital. This section also typically includes information about plans for major material capital expenditures.

Management also uses this section to explain the results of operations. The team can explain unusual events, material transactions, or significant economic changes. The company often uses this opportunity to explain why net revenues and expenses vary from expected or budgeted financial plans. The company may also use this section to highlight its successes, such as how a specific product outperformed during its launch or how its entry into new markets has exceeded expectations.

MD&A is often used to highlight aspects of the business's accounting practices. Some accounting rules require professional judgment; therefore, the section may include explanations of how capital assets, inventory, or other assets are valued or accounted for. It can also explain how it arrived at estimates for other amounts on financial statements, such as an allowance for bad debt and resulting bad debt expense.

Limitations of Management Discussion and Analysis (MD&A)

The MD&A section of a 10-K primarily uses words to explain a financial position instead of numbers. Therefore, management can use language that it feels is appropriate to manipulate financial performance or its expectations. Whereas financial reporting is governed by generally accepted accounting principles (GAAP), a company has the flexibility to represent itself as it sees fit in the Management's Discussion and Analysis (MD&A) section.

When management prepares this section, it is aware that this information will be available to the public. This means that competitors can extract information on the company's strategy. Therefore, in addition to wanting to paint a rosy picture, the company wants to be as secretive as possible without revealing information that could take away its competitive advantage.

The MD&A section is entirely up to interpretation. This means a company may interpret data one way when, in reality, the data might demonstrate an entirely different picture. Even if management puts forth a projection to the best of its knowledge, its analysis is still prone to bias and error, and projections may not materialize.

Example of Management Discussion and Analysis (MD&A)

The images below are from Amazon's 2021 10-K filing. In Item 7 of the notes to its financial statements, the company provides a forward-looking projection of what's to come for the company. You'll note that, to protect intellectual property and not reveal too many strategic plans, the wording in this section is somewhat vague.

Amazon provides an overview of operations. This includes the primary sources of income, its strategic financial focus, and other means of success. Again, the company offers some insights into operations without revealing too many strategies that companies can directly steal.

There are other sections after the critical accounting judgements section, but this is the last example shown here. This section confirms that the financial statements have been prepared in conformance with GAAP and explains how management arrived at certain estimates.

The Bottom Line

The management discussion and analysis section of a set of financial statements is management's opportunity to explain how the company did and how it will perform. The section is required to be included in a publicly traded company's financial statements, and it usually contains an overview, forward-looking projection, and explanation of decisions.