Management’s Discussion & Analysis

I've been reading financial statements for 30 years, and even though I'm good at it, there are still some items that mystify me. Imagine what the average investor faces when attempting to interpret the financial statements of the companies he or she has invested in. The regulators' answer: Management's Discussion and Analysis, a narrative dissertation accompanying annual and interim financial statements in which company management attempts to explain what their financial statements really mean. There are a couple of questions that could be asked at this point. Firstly, why are financial statements written in such a way that they require explanation in a separate document? And why does anyone think that the management of a junior public company is qualified to interpret them? To appreciate that this is a lot to ask, one only has to attempt to understand the principals upon which "stock-based compensation" is charged as a current expense to net earnings. (It should be a charge, but only when the option is exercised in-the-money) But MD&A is here to stay, so here are a few tips to make your quarterly foray into this quagmire a little easier to endure.

Firstly, DO NOT take your last quarter's MD&A and simply substitute the numbers from the current quarter. Things change from quarter to quarter, often dramatically, and this practice can produce some unintended and occasionally amusing results. One of my clients explained in one quarterly MD&A that one of its prime sources of capital was net profits from operations. That was true that quarter, with a healthy six figure profit. The next quarter they used exactly the same disclosure and simply substituted the current quarter profit number. Unfortunately, that number was negative to the tune of $200,000. Not only did the disclosure make no sense, but the client failed to explain how they intended to cover their capital needs in the face of negative profitability, which was precisely what the instructions to the MD&A form required them to do. It's important each quarter to read the instructions to the MD&A form and respond intelligently to the disclosure requirements of each section, in light of your company's actual performance as reflected in your financial statements. You can obtain a copy of the current MD&A form at this link: MD&A Instruction Form

Secondly, DO NOT leave this to the last minute. How is it that, quarter after quarter, the majority of clients finally produce their financial statements within hours of the filing deadline. This is probably the single most significant reason why MD&A gets screwed up; there's just not enough time to prepare it intelligently. How hard can it be to assemble data for a period that ended two months ago in time to produce a financial statement in a timely fashion? If you have this problem, figure out why and fix it.

Thirdly, give bad news the same weight as good. If you're a copper producer and expect to be less profitable in the foreseeable future due to declining copper prices, then say so in plain language. Your investors will have figured this out long before your MD&A is published, and in my experience the investing public appreciates and rewards candour. I've seen some tortured language used in an attempt to obscure the obvious - it doesn't work and it's not appreciated.

This may be tough to swallow, but many junior companies just don't have the talent to produce a well-written and instructive MD&A. To do so requires a good understanding of your company's business, including the external forces that affect it, a good command of the English language and the ability to reduce sometimes complicated concepts to writing, and the ability to read and interpret financial statements. This can be a lot to ask of a CFO that's being paid primarily in out-of-the-money stock options. And don't think you can just slough this off and no one will notice, your potential investors notice, and the BC Securities Commission conducts regular compliance reviews. If you need help in preparing your MD&A, call your accountant or securities lawyer for assistance.

And there's more good news, commencing January 1, 2011 Canadian generally accepted accounting principles will be replaced with IFRS, International Financial Reporting Standards. That means dramatic changes to financial reporting and financial statement presentation, and the accompanying MD&A. Incidentally, as the changeover date approaches, your MD&A is required to disclose your company's plans for converting to IFRS, and the effect it's expected to have on your financial reporting. Companies with December 31 year ends are expected to discuss in their annual MD&A for the year ending December 31, 2008, the status of the key elements and timing of their changeover plan. For the interim periods in 2009, MD&A should provide an update of the progress made on the changeover plan and any changes in the plan. For the financial year ending December 31, 2009, detailed disclosure is required concerning the company's preparations for the changeover and the major identified differences between current accounting policies and those the company is required or expects to apply under IFRS. Need help? Go back to the last sentence of the immediately preceding paragraph.