Directors and shareholders should focus on corporate systems not just the numbers

monitoring financial reportingIt will be some time before the former directors of retail giant Tesco appear in court following investigations that arose out of an over-statement of profits revealed by Tesco in 2014.

So far the Serious Fraud Office (SFO) has charged three of them with fraud and false accounting and the UK’s Financial Reporting Council (FRC) is still investigating Tesco’s former auditors Price Waterhouse Cooper (PwC).

Monitoring businesses systems

In our view it is a mistake for shareholders and directors to simply focus on the numbers as this case highlights. Our view is formed by our observation of corporate insolvency that are generally caused by people and systems failures, rather than the financial symptoms that everyone focuses on.

Accordingly, it is more important is to look at the systems and the corporate culture behind the numbers.

Tesco has been well known for aggressively managing its figures to present its business in the best and most profitable light. But it is not the only example of everyone looking in the wrong direction. Another was the collapse of Barings Bank and loss of £827 million in 1995.

While it is obvious that shareholders may primarily invest in a company in order to earn profits, it is surely in their interests to monitor the managers and understand the systems behind such reporting in order to have confidence in a company’s potential for longevity and continued success.

Surely, manipulating the numbers, as was the case of Nick Leeson at Barings and appears to have been the case at Tesco, might have pleased shareholders in the short term but the question is whether such a culture is sustainable.

Independent monitoring on behalf of shareholders and advice for directors, such as the thorough examination that is used by rescue and turnaround advisers when a company is in difficulty, will reveal whether a company’s accounting and reporting systems are conservative or aggressive when reporting its profits.

Short term thinking is not necessarily in the best interests of investors/shareholders who might consider independent monitoring and advice. Such independent advice is normally only brought in when a company is in difficulty or insolvent but it may be useful to have such a monitoring system alongside the auditors.

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