Importance of Reliable Financial Statements: Tesco Case

Stock price of Tesco PLC recently dropped. The reason? Its accounting reports lacked reliability regarding its expected revenues. This affair illustrates the importance for companies to have clear and reliable accounts. As a result, you should always check that the auditor’s opinion in the annual reports is clean.

Tesco’s annual report impacted its stock price

Tesco has to deal with uncertain revenues. Tesco takes advantage of its direct contact with customers and gets extra incentives from its suppliers—brands like Coca-Cola or Pepsi—that are distributed within its stores. Suppliers pay the so-called rebates when a certain level of sales is hit. Because Tesco cannot predict if a determined level of sales will be hit, it cannot determine how much it will receive from these rebates. So a part of Tesco’s revenues is an approximation.

How Tesco evaluates its extra revenues? Managers make rough guess on how much rebates will be received. These estimates are based on subjective elements. And lately, Tesco has been overly optimistic. It based its expected rebates on historic precedent rather than on current sales. The recent decline of the company’s sales pointed out the lack of clear evidence for these extra revenues.

Shareholders need reliable financial statements

Shareholders’ response to these uncertain revenues caused share price to drop. The Tesco case shows how important it is for a company to have reliable financial statements. Although, PwC—Tesco’s auditor—highlighted the recognition of commercial income as an issue, the stock price significantly dropped after analysts started highlighting the lack of certainty for these revenues. Shareholders obviously lost confidence in Tesco.

Stock price drop of Tesco

As investors, we need to be able to trust the numbers put in accounting statements. If we do not know how the company is going, we won’t invest our money in it company. Therefore, we need a clean auditor’s opinion on financial statements.

Take Away

Always look at auditor’s opinions in annual reports.