Performance, position and cash flows – Why management commentary explains numbers but not change

IFRS Practice Statement 1 places exceptional emphasis on this point: management commentary should not merely describe outcomes, but explain the drivers of change in performance, financial position and cash flows. This is not a stylistic preference. It is a governance requirement.

Boards rarely struggle to understand what happened.
They struggle to understand why it happened and whether it will happen again.

The structural weakness of “period reporting”

Financial statements are inherently period-based. They capture outcomes at a point in time or over a defined interval. Management commentary is meant to provide the bridge between periods.

In practice, that bridge is often weak.

Performance is explained in isolation:

revenue growth attributed to “market demand”,
margin pressure attributed to “cost inflation”,
cash flow volatility attributed to “timing effects”.

Each explanation may be technically correct. Collectively, they often fail to explain the underlying mechanics of change.

IFRS Practice Statement 1 expects management to go further:

What changed in the business?
Which assumptions shifted?
Which drivers strengthened or weakened?
Which effects are structural and which are temporary?

Without this, users are left to extrapolate blindly.

Here is the link to the IFRS Practice Statement 1: Management Commentary on IFRS.org.

Explaining change is a governance discipline

Explaining change forces management to confront uncomfortable questions:

Which levers are still under control?
Which dependencies have intensified?
Which buffers have weakened?
Which trade-offs were made implicitly?

This is why explanations are often vague. Clear explanations expose accountability.

From a governance perspective, weak explanations are not neutral. They increase uncertainty, reduce predictability and shift risk to boards and stakeholders.

IFRS Practice Statement 1 treats explanation of change as a core management responsibility, not as optional narrative.

Performance: more than variances

Many management commentaries explain performance through year-on-year variances:

volume effects,
price effects,
mix effects.

While useful, this approach remains mechanical.

IFRS Practice Statement 1 expects management to explain why those effects occurred, not merely that they did.

For example:

Why did pricing power weaken?
Why did costs become less flexible?
Why did scale benefits not materialise?
Why did performance become more sensitive to external conditions?

These questions link performance to the business model, resources and relationships discussed in Blogs 3 and 4.

Without that linkage, performance explanations remain shallow.

Financial position: the silent accumulation of change

Changes in financial position are often treated as secondary to performance. Balance sheets are explained cursorily, if at all.

Yet balance sheets accumulate the long-term consequences of decisions:

Explaining change in Management Commentary

working capital policies,
investment choices,
financing structures,
risk retention.

IFRS Practice Statement 1 explicitly requires management commentary to explain changes in financial position, not just results.

For boards, this is critical. Deterioration in resilience almost always appears on the balance sheet before it appears in profit and loss.

Ignoring balance sheet dynamics is a governance blind spot.

Cash flows: where explanations most often fail

Cash flow explanations are frequently the weakest part of management commentary. They are often reduced to:

“timing differences”,
“temporary movements”,
“one-off effects”.

IFRS Practice Statement 1 expects more.

Cash flows reveal:

the quality of earnings,
the sustainability of the business model,
and the organisation’s capacity to absorb shocks.

Boards should be particularly alert when:

profits grow but cash flows weaken,
working capital absorbs increasing amounts of cash,
or capital expenditure quietly rises without clear strategic rationale.

These are not accounting phenomena. They are business model signals.

Why users care about change, not just results

Investors, lenders, regulators and boards do not base decisions on absolute numbers alone. They base them on direction, momentum and durability.

A result without explanation of change:

cannot be extrapolated,
cannot be stress-tested,
and cannot be governed effectively.

IFRS Practice Statement 1 recognises this by prioritising explanation over narration.

What this Part establishes

This part establishes a foundational principle:

Management commentary that reports results without explaining change fails its governance purpose.

Explaining change is where accountability, foresight and credibility converge.

When explanations hide structural change

If Part I established that explaining change is central to the purpose of management commentary, Part II confronts a harder truth: many explanations actively conceal what is changing. Not through misstatement, but through abstraction, aggregation and repetition.

This is where governance risk accumulates.

IFRS Practice Statement 1 does not merely ask management to explain change. It asks management to explain the nature of that change—whether it is cyclical or structural, controllable or imposed, reversible or cumulative.

Boards that fail to press for this distinction often discover too late that yesterday’s “temporary effects” were tomorrow’s new normal.

The comfort of generic explanations

Certain phrases appear with striking regularity in management commentary:

“challenging market conditions,”
“inflationary pressures,”
“timing differences,”
“investment phase,”
“temporary headwinds.”

Each phrase can be accurate. None explains much.

Generic explanations provide comfort because they diffuse responsibility. If margins decline due to “market conditions,” no internal assumption needs to be questioned. If cash flow weakens due to “timing,” no structural issue needs to be addressed.

IFRS Practice Statement 1 implicitly challenges this comfort. It expects management to move beyond labels and explain mechanisms.

Boards should treat generic explanations as prompts for deeper inquiry, not as answers.

Structural versus cyclical: the distinction that matters

One of the most critical governance failures is the inability—or unwillingness—to distinguish between cyclical fluctuation and structural change.

Examples include:

pricing pressure described as temporary competition,
rising costs attributed to inflation,
increasing leverage justified by growth investments,
working capital expansion framed as scale effects.

Each may be cyclical. Each may also be structural.

IFRS Practice Statement 1 expects management to explain why it believes change is temporary or permanent. What evidence supports that assessment? What assumptions underpin it? What would contradict it?

Without this explanation, boards are forced to accept management’s optimism on trust.

Performance explanations that ignore leverage

Performance explanations often focus on income statement effects while ignoring operating leverage.

Margins do not decline simply because revenue slows. They decline because costs are rigid. Earnings volatility increases because fixed commitments grow. Sensitivity to volume increases because flexibility has eroded.

IFRS Practice Statement 1 encourages management to explain performance in the context of the business model and resources. When cost structures change—through outsourcing, digitalisation, regulation or scale—performance volatility changes too.

Boards should be alert when performance explanations do not address cost elasticity and leverage effects.

Balance sheet drift: the slow build-up of constraint

Changes in financial position are frequently treated as secondary effects of performance. In reality, they often signal structural shifts earlier.

Examples include:

steadily rising working capital intensity,
increasing capitalisation of costs,
growing reliance on short-term financing,
declining liquidity buffers.

These changes rarely reverse automatically. They accumulate.

IFRS Practice Statement 1 explicitly requires explanation of changes in financial position because they reveal how decisions compound over time.

Boards that focus narrowly on profit trends risk missing early balance sheet stress.

Cash flow explanations that minimise risk

Cash flow is where explanations are most often softened.

Common patterns include:

repeated references to “timing,”
persistent “one-off” cash outflows,
growth investments without clear return linkage,
widening gaps between earnings and cash generation.

IFRS Practice Statement 1 expects management to explain cash flows as outcomes of operating reality, not as accounting noise.

For governance, cash flow explanations deserve heightened scrutiny. Weak cash generation is rarely accidental. It reflects:

customer payment behaviour,
supplier power,
inventory dynamics,
capital intensity,
or execution discipline.

Boards should question explanations that normalise weak cash flows without addressing underlying drivers.

Read more on the New Zealand External Reporting Board, XRB.nz: IFRS Practice Statement 1 – Management Commentary (MPS1).

Why explanations lag reality

There are structural reasons why management commentary often underplays structural change:

early signals are ambiguous,
acknowledging structure reduces flexibility,
transparency invites external pressure,
internal consensus may be lacking.

IFRS Practice Statement 1 recognises uncertainty, but it does not endorse delay. It expects management to articulate what is changing, what is uncertain, and what management is watching.

Boards should see reluctance to explain as a governance issue, not a communications one.

The cumulative effect of weak explanations

Individually, weak explanations may appear harmless. Collectively, they create a narrative that:

understates risk,
overstates reversibility,
and delays corrective action.

This cumulative effect is why business failures often appear sudden from the outside, despite years of warning signs in performance, position and cash flows.

IFRS Practice Statement 1 is designed to surface these signs earlier—if boards insist on substance.

Why this Part matters for boards

This Part highlights a core governance insight:

Explanations shape perception. Perception shapes decisions.

When management commentary consistently frames change as temporary, boards will wait. When explanations surface structural shifts, boards can act.

The difference lies not in the numbers, but in the narrative discipline applied to them.

Board responsibility, early-warning signals and explaining change as a governance discipline

If Part I established that management commentary must explain change rather than merely report results, and Part II showed how weak explanations obscure structural shifts, Part III addresses the decisive governance question: how boards and audit committees should actively use explanations of change as an oversight tool.

This is where IFRS Practice Statement 1 moves beyond reporting guidance and becomes a governance framework.

From narrative output to oversight input

Most boards read management commentary as a descriptive output that accompanies the financial statements. IFRS Practice Statement 1 implicitly expects something different: management commentary should function as an analytical input for governance.

That shift is subtle but profound.

Boards should not ask whether performance, position and cash flows are explained. They should ask whether those explanations:

make future outcomes more predictable,
reveal where control is weakening or strengthening,
and clarify which trends are reversible and which are not.

When explanations do not serve these purposes, they fail their governance function—even if they are technically accurate.

Explaining change as an early-warning system

One of the most important but least appreciated roles of management commentary is its leading-indicator value.

Before problems appear in headline results, they usually emerge as changes in:

earnings quality,
balance sheet resilience,
cash flow conversion,
or sensitivity to external factors.

IFRS Practice Statement 1 requires management to explain these developments precisely because they precede crises.

Examples are familiar:

margins hold, but require increasing working capital,
profits grow, but cash flows weaken,
balance sheets expand, but flexibility declines,
volatility increases despite stable strategy.

Each of these is a warning sign. Without disciplined explanation, they are easily dismissed as noise.

Boards that treat explanations of change as early-warning signals gain time. Boards that do not, lose it.

The audit committee’s role in challenging explanations

Audit committees traditionally focus on whether numbers are correct. IFRS Practice Statement 1 expands this responsibility to whether the story behind the numbers is credible.

This includes challenging:

whether changes are genuinely temporary,
whether “timing effects” recur suspiciously often,
whether investments produce observable operating leverage,
and whether cash flow explanations align with business reality.

Audit committees should view weak explanations not as communication issues, but as assurance gaps.

If management cannot convincingly explain why performance, position or cash flows changed, the quality of financial reporting itself is undermined.

Accountability emerges through explanation

Explaining change forces accountability in ways that reporting results does not.

Results can be attributed to external factors. Change explanations require management to articulate:

which assumptions were tested,
which decisions mattered,
which levers worked,
and which did not.

This is why explanations are often cautious. They expose judgment.

IFRS Practice Statement 1 deliberately places this responsibility on management. It does not require certainty, but it requires reasoned articulation.

Boards should insist on this articulation even when uncertainty remains.

Connecting change to the business model

Explanations of change are only meaningful when anchored in the business model.

Performance does not change randomly. It changes because:

pricing power shifts,
cost structures evolve,
capital intensity increases,
relationships tighten or loosen,
or risks migrate.

These dynamics were explored in Blogs 3 and 4. Blog 5 completes the circle by showing how their effects surface in numbers.

IFRS Practice Statement 1 expects management commentary to connect these layers:

business model dynamics explain changes in performance,
resource and relationship shifts explain balance sheet movement,
risk realisation explains cash flow volatility.

Without this integration, explanations remain fragmented.

A practical framework for boards

Boards and audit committees can operationalise explanation oversight by consistently testing explanations against five questions:

Direction
Does the explanation clarify whether change is improving or weakening resilience?
Durability
Does it distinguish between temporary effects and structural shifts?
Drivers
Does it identify specific mechanisms, not just outcomes?
Reversibility
Does it explain what would need to happen for trends to reverse?
Consistency
Do explanations align across performance, position and cash flows?

If these questions cannot be answered from management commentary, governance visibility is impaired.

Why explaining change builds credibility

Stakeholders do not expect management to control all outcomes. They expect management to understand and explain them.

Clear explanations:

increase confidence in future guidance,
reduce surprise when conditions deteriorate,
and enhance trust when difficult decisions are required.

IFRS Practice Statement 1 recognises that credibility is built through explanation, not optimism.

Boards that prioritise explanation strengthen not only oversight, but legitimacy.

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Explaining change in times of stress

The importance of disciplined explanation increases sharply during:

economic downturns,
rapid growth phases,
restructurings,
regulatory change,
or capital market volatility.

In these periods, results alone are misleading. Direction and momentum matter more.

IFRS Practice Statement 1 positions management commentary as the place where this context must be provided.

Boards should insist on greater explanatory depth precisely when pressure rises.

Integrated conclusion – Explanation is the anchor of credible governance

Management commentary that reports numbers without explaining change reduces governance to hindsight.

IFRS Practice Statement 1 challenges this by making explanation—not narration—the core obligation. It requires management to explain how and why performance, financial position and cash flows evolve, and what that evolution implies for the future.

For boards and audit committees, this is not a reporting refinement. It is a governance discipline.

Business models erode quietly. Balance sheets accumulate stress gradually. Cash flows reveal truth early.

explaining change in management commentary explaining performance financial position cash flows management commentary change drivers cash flow explanation IFRS balance sheet change governance

Only disciplined explanation connects these signals in time to act.

That is why, under IFRS Practice Statement 1, explaining change is not an accessory to reporting—it is the foundation of credible oversight.

FAQ’s – IFRS Practice Statement 1 performance explanation

FAQ 1 – What does IFRS Practice Statement 1 mean by “explaining change”?

Explaining change means clarifying why performance, financial position and cash flows have changed between periods, not merely stating that they have. IFRS PS 1 requires management to identify drivers, assumptions and mechanisms behind change so users can assess sustainability, not just outcomes.

FAQ 2 – Why are explanations of change often weak in management commentary?

Many explanations rely on generic labels such as “market conditions” or “timing effects.” While often accurate, they obscure whether change is structural or temporary. IFRS PS 1 challenges this by requiring mechanism-based explanations rather than descriptive summaries.

FAQ 3 – Why is explaining change a governance issue rather than a reporting detail?

Boards govern direction, resilience and risk. Without clear explanations of change, boards cannot assess whether trends are controllable, reversible or compounding. Weak explanations delay intervention and reduce predictability, making them a governance risk rather than a stylistic flaw.

FAQ 4 – How should boards assess explanations of performance change?

Boards should test whether explanations identify specific drivers (pricing, cost rigidity, leverage), distinguish structural from cyclical effects, and link outcomes to business model dynamics. Variance analysis alone is insufficient under IFRS PS 1.

FAQ 5 – Why are balance sheet and cash flow explanations critical early-warning signals?

Balance sheets accumulate long-term consequences of decisions, while cash flows reveal earnings quality and resilience. IFRS PS 1 emphasises explaining changes in both because stress appears there before it shows in profit and loss.

FAQ 6 – How does explaining change connect to the business model?

Performance, position and cash flows change because the business model evolves—through shifts in pricing power, cost structure, capital intensity or relationships. IFRS PS 1 expects management commentary to connect numeric change back to business model mechanics, creating a coherent governance narrative.