Management discussion and analysis is part of the structure of a company’s annual report. This section of the annual report enables the management of a company to discuss various aspects of the business. These aspects normally include the past and the present issues that affect the company. Through past years’ results, management has an idea of what to expect in the future. Since it not only focuses on the past but also on the present and the future of a company, it is of major importance to the company as a whole because of the following reasons.
Through the management discussion and analysis section, company’s management gives a clear view of what constitutes and what will constitute the capital resources of the company. The financial statements show the long term assets that the company has; however, it is not enough. This is because; provided the business continues as a future entity it needs more capital resources to fund long term commitments. Therefore, such discussions, give more information on where the sources of funds will come from. Hence, the management of a company is obliged to discuss in detail the funding for such commitments, and that is through equity or debt. This establishes a clear tradeoff between equity and debt financing to meet the needs of affected stakeholders such as shareholders and other investors (Stanko and Zeller 19).
Cash flow statements help to show the liquidity position of a company. However, users of the information need a clear view of how the company will deal with future deficiencies or surpluses in cash. Management discussion gives more information on how to deal with these uncertainties. For instance, if the cash generated is more than expected, the management team discusses what it intends to do with the cash, for instance, to pay off short term or long term debt. If on the other hand a deficiency occurs, management has to give a clear indication of how it intends to remedy the situation, for instance through disposing of liquid assets (Stanko and Zeller 20).
Management discussion is also important because it helps to explain the results from the operations of the business. The discussion and analysis will focus on explaining circumstances that led to the reported income in the financial statements. Such incidences include; infrequent transactions which lead to increase or decrease in income, economic changes like inflation rates which have significant impact on the reported income. Also it is the responsibility of management to tell users the extent to which such occurrences affect reported income. They also need to state clearly how they will sustain future profitable occurrences or avoid loss incurring events (Stanko and Zeller 19).
This section is also important because, the top management gives its assessment and comparison of previous years’ performance, for instance, the last two or three years. Management discloses what they expect to happen in the present year and in the future through the discussion. They also give an insight of what strategies they plan to undertake and the business risks likely to face such undertakings. Such information is crucial to existing and potential investors. It helps them know what they expect to happen to their investments in terms of how the business performs, and what the management intends to do to keep the business profitable (Wahlen et al. 38).
From the above, it is clear that management discussion and analysis information is a very important section of the annual report. It helps the users of the information understand management’s view of the liquidity, capital resources, operational results, company performance and management’s expectation of the future of the company. Since management will always give a positive picture of the company, it is advisable, that users develop a skeptical attitude when reading this information.
Stanko, Brian, and Thomas Zeller. Understanding Corporate Annual Reports: A User’s Guide. New Jersey: John Wiley & Sons, 2003. Print.
Wahlen, James M, et al. Financial Reporting, Financial Statement Analysis, and Valuation: A Strategic Perspective. New York: Cengage learning, 2010. Print.