The New MD&A Rule:  Part Eight – Liquidity and Capital Resources

By George Wilson

This is the eighth and last in a series of blog posts in which we are diving into the details of the SEC’s Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information Final Rule. This rule was published in the Federal Register on January 11, 2021.  It is effective for filings on or after February 10, 2021.

The rule’s transition provisions include a mandatory transition date but also allow voluntary early compliance.  The mandatory transition date is each company’s first fiscal year that ends after August 9, 2021, 210 days after the effective date.  Companies may voluntarily apply the new rule, on an S-K item-by-item basis, in any filing made on or after the effective date of February 10, 2021.

This means a company that files a Form 10-K on or after February 10, 2021, has the option to early implement this new MD&A (S-K Item 303) guidance.  Even if a company does not implement the rule early, it is not too soon to start planning for any required changes.  And, hopefully, this exploration can be a possible stepping-off point for a process to review and possibly improve MD&A as a communication document.

In this first post, we overviewed the MD&A changes.  The second, thirdfourth, fifth,  sixth, and seventh posts reviewed and discussed:

The addition of an objective to S-K Item 303,

New critical accounting estimate disclosures

Changes to results of operations and known trend discussions,

The elimination of a separate paragraph with disclosure requirements for off-balance sheet arrangements,

Replacing the Contractual Obligations Table with a Principles-Based Requirement, and

Sequential Quarterly Analysis In Interim MD&As.

This eighth and last post addresses perhaps the most significant change in the final rule, expansion and clarification of the requirements for the discussion of liquidity and capital resources.  The old guidance for this part of MD&A was very brief and “high level”:

Old S-K Item 303 (A):

(1) Liquidity. Identify any known trends or any known demands, commitments, events or uncertainties that will result in or that are reasonably likely to result in the registrant’s liquidity increasing or decreasing in any material way. If a material deficiency is identified, indicate the course of action that the registrant has taken or proposes to take to remedy the deficiency. Also identify and separately describe internal and external sources of liquidity, and briefly discuss any material unused sources of liquid assets. 

(2)  Capital resources. (i) Describe the registrant’s material commitments for capital expenditures as of the end of the latest fiscal period, and indicate the general purpose of such commitments and the anticipated source of funds needed to fulfill such commitments. 

(ii) Describe any known material trends, favorable or unfavorable, in the registrant’s capital resources. Indicate any expected material changes in the mix and relative cost of such resources. The discussion shall consider changes between equity, debt and any off-balance sheet financing arrangements. 

This old MD&A guidance did not provide a clearly articulated goal for the discussion of liquidity and capital resources.  As a result, in many MD&As, it is challenging to understand how a business has funded itself in its most recent year and how it plans to fund itself in future years.  

The new liquidity and capital resources disclosure requirements clarify the purpose and objective of this disclosure and add helpful detail.  Included are requirements to:

Provide an overall analysis of cash requirements by type of obligation and discuss how the company will generate or obtain liquidity to meet these requirements,

Analyze liquidity and capital resources in both the short-term and long term, and

Include cash requirements related to contractual obligations in the discussion.

These requirements are spelled out in this new language in S-K Item 303:

(1) Liquidity and capital resources. Analyze the registrant's ability to generate and obtain adequate amounts of cash to meet its requirements and its plans for cash in the short-term (i.e., the next 12 months from the most recent fiscal period end required to be presented) and separately in the long-term (i.e., beyond the next 12 months). The discussion should analyze material cash requirements from known contractual and other obligations. Such disclosures must specify the type of obligation and the relevant time period for the related cash requirements. As part of this analysis, provide the information in paragraphs (b)(1)(i) and (ii) of this section.

(i) Liquidity. Identify any known trends or any known demands, commitments, events or uncertainties that will result in or that are reasonably likely to result in the registrant's liquidity increasing or decreasing in any material way. If a material deficiency is identified, indicate the course of action that the registrant has taken or proposes to take to remedy the deficiency. Also identify and separately describe internal and external sources of liquidity, and briefly discuss any material unused sources of liquid assets.

(ii) Capital resources. (A) Describe the registrant's material cash requirements, including commitments for capital expenditures, as of the end of the latest fiscal period, the anticipated source of funds needed to satisfy such cash requirements and the general purpose of such requirements.

(B) Describe any known material trends, favorable or unfavorable, in the registrant's capital resources. Indicate any reasonably likely material changes in the mix and relative cost of such resources.

The primary focus of these new requirements is a clear discussion of cash requirements, including requirements from contractual obligations, and an analysis of how those cash requirements will be met.  This discussion must include both short- and long-term analyses.  While we could discuss how old FR 72 included similar guidance, it is now included in the core S-K Item 303 requirements.

As we discussed in this post, the requirement for the contractual obligations table was removed in the Final Rule and replaced with this more principles-based instruction:

4. For the liquidity and capital resources disclosure, discussion of material cash requirements from known contractual obligations may include, for example, lease obligations, purchase obligations, or other liabilities reflected on the registrant's balance sheet. Except where it is otherwise clear from the discussion, the registrant must discuss those balance sheet conditions or income or cash flow items which the registrant believes may be indicators of its liquidity condition.

The SEC made this overall comment about improving this disclosure in the Final Rule:

The amendments to Item 303(b) are intended to clarify the requirements while continuing to emphasize a principles-based approach focused on material short- and long-term liquidity and capital resources needs, while also specifying that material cash requirements from known contractual and other obligations should be considered as part of these disclosures. Specifically, these amendments: 

  • Create a new Item 303(b)(1) to provide the overarching requirements for liquidity and capital resources disclosures in order to clarify these requirements; 

  • Incorporate in Item 303(b)(1) portions of current Instruction 5 to Item 303(a), which defines “liquidity” as the ability to generate adequate amounts of cash to meet the needs for cash, clarifying its applicability to the liquidity and capital resources requirements more generally; 

  • Codify prior Commission guidance that specifies that short-term liquidity and capital resources covers cash needs up to 12 months into the future while long- term liquidity and capital resources covers items beyond 12 months;

  • Require the discussion on both a short-term and long-term basis; and

  • Require the discussion to analyze material cash requirements from known contractual and other obligations and such disclosures to specify the type of obligation and the relevant time period for the related cash requirements. 

The Final Rule’s principles-based expansion and clarification of the liquidity and capital resources discussion provides an important opportunity to improve MD&A.  This discussion is, unfortunately, frequently hard to understand.  While there are many causes for this lack of clarity, the  brevity of the old requirements is likely one of them.  With the new requirements in S-K Item 303, many companies have a chance to improve the liquidity and capital resources section of their MD&A. 

As always, your thoughts and comments are welcome!

Other news