Importance of financial information.

1.0 Introduction

The accuracy of decisions in the business environment is dependent on the availability of accurate data on a timely basis. Financial information is an important proponent of information needed in decision making. This information is found in financial statements prepared by businesses for different classes of stakeholders. These statements include the statement of financial position also referred to as the balance sheet, comprehensive income statement also referred to as the profit and loss account, and cash flow statement. The three key documents contain valuable information that aid decision making. The balance sheet shows the company’s assets, liabilities, and equity that helps identify the financial position of a company.  It is used to assess the total value of a company thus guiding investors. The income statement shows the company’s revenue, expenses and profit.  In other words, it shows how a company is generating revenue and the costs associated with the revenue. The cash flow statement gives details regarding liquidity thus assessing the company’s ability to meet its liabilities as they fall due.  Tesco is a public limited company, and its financial information is used by many stakeholders.  The company is the world’s third largest retailer based on profit and also ranked the world’s twelfth largest based on revenue. The company operates 12 countries with over 6000 stores (Barnes2011). The company’s operating income for the year 2017 was £1,280 million with total revenue of £55,917 million (Morningstar 2017).  The London based company was established in the year 1919 and has been pursuing an aggressive expansion strategy making it among the world’s leading retailers. Financial reporting in the company affects many stakeholders due to its large size that leads to complex relationships with different classes of stakeholders.

2.0 Financial Reporting Regulations

Financial reporting is governed by a body of standards established at the international and local level. The needs of financial information users are diverse, and this makes it necessary to revise the regulatory framework to ensure financial reporting is in line with the current user needs. However, it is technically impossible to develop financial information that fully meets the needs of all users. The preparation of Tesco’s financial statements is guided by the international financial reporting standards as well as the company law.  Currently, the UK financial reporting environment is still being controlled by the EU endorsed financial reporting standards (Revsine 2012).  The company law of the United Kingdom requires the directors of a company incorporated in the UK to prepare financial statements that reflect a true and fair view of the entity’s state of affair. The law recognizes two types of accounts which are IAS accounts and the Company Act accounts (Revsine 2012). Preparing IAS accounts is guided by the IFRS (International Financial Reporting Standards) (Ball 2006).  The International Financial Accounting Standards Board (IASB) is tasked to create and revise the IFRS.  On the other hand, the preparation of the Companies Act Accounts is guided by the Financial Reporting Standards (FRS) as well as the company law’s disclosure requirements. FRSs are established by the Financial Reporting Council that is charged with the responsibility of regulating the financial reporting environment in the UK. The company law demands Tesco make public its financial statements because its shares are listed in a regulated market.  IAS regulations demand the company to prepare consolidated financial statements showing the company’s operations within and outside the country. This requirement ensures that users of financial statements have a grasp of the company state of affairs by only reading the financial statement.

There have been concerns that the International Accounting Standards Board is overburdened by the responsibility of ensuring financial information meets the needs of different users. Tesco’s stakeholders are many and have diverse information needs. The company is a major player in the global retail industry implying that its supply chain connects goes beyond the UK. As a result, the company’s stakeholders increase making it necessary to develop financial statements that meet the interests of these stakeholders.  Considering the user’s diversity, it is difficult for the International Accounting Standards Board to come up with financial reporting standards that enable a multinational company to meet information needs of vast stakeholders.

3.0 Qualitative Characteristics of good Financial Information

Financial statements are prepared by the management for use by different stakeholders.  It is the management’s responsibility to implement internal control measures aimed at ensuring that financial statements reflect the free and fair view of the state of affairs in the company. Being the highest organ in corporate governance, the board of directors implement measures aimed at safeguarding the quality of financial reporting. In line with this aspiration, an internal audit function is established to scrutinize accounting operations to ensure they comply with the highest regulatory and ethical standards. The board is made of the executive and the non-executive directors where the responsibility of establishing and controlling the internal audit department lies with the non-executive directors to ensure the independence of internal auditors. Having established the relevant internal control systems, financial information is expected to portray some specific qualitative characteristics.

Relevance is one of the qualitative characteristics of financial information. The relevance of financial information considers the user’s information needs. Financial statements should contain information that reflects the user’s needs. The time factor can influence the relevance of financial information where more recent information is more useful than old information (Obadiah 2007). The business environment is dynamic and this feature demands decision makers to be equipped with the most recent information. Consistency is another qualitative characteristic of financial information.  Transactions should be handled the same to enhance the quality of financial information.  The accounting process starts by recording transactions in the general ledger that are then condensed into a financial statement.  According to Obaidat 2007, consistency makes control easy as it is possible to compare the treatment of a transaction against a predetermined criterion.  Comparability is an essential qualitative feature if financial information. Financial statements should be prepared in a way that supports comparison with statements belonging to other businesses, and this provides a basis for evaluating business performance (Obaidat 2007). For instance, comparing Tesco’s financial statements with those of peers helps to determine the company’s performance. Understandability is another important essential quality characteristic of financial information.  Financial statements are prepared by professional accountants with an in-depth understanding of financial reporting. This reality creates the risks of using technical jargon. The users of financial statements are ordinary people who cannot understand technical financial reporting language (Chaney, Faccio, & Parsley 2011).  According to Chaney, Faccio, & Parsley 2011, it is the responsibility of an accountant to prepare financial statements that can be understood by users of different backgrounds. Making financial statements too complex can compromise their usefulness.

4.0 Users of Financial Information

Decision making in the business environment requires accurate financial information. Some decisions have far-reaching ramifications making it necessary to conduct thorough research during decision making. A business cooperates with different classes of stakeholders that need accurate financial information when making decisions regarding dealing with the business. Tesco has many stakeholders that perform specific tasks in the supply chain.  The relationships with these stakeholders determine business success. A prudent leadership gives the right emphasis to managing relationships with stakeholders to make these relationships sustainable.  Provision of the right information to the stakeholders is one of the most effective strategies for managing relationships with stakeholders. Financial information is a key ingredient in managing relationships with stakeholders. Tesco’s financial reporting provides information to many external stakeholders thus providing a basis for making key decisions. Some of the users of Tesco’s financial information include lenders, the government, suppliers, customers, and investors.

4.1 Lenders

Lenders perform an important role in a business as they finance operations. Lenders have to a great extent supported Tesco’s aggressive expansion strategy. The company’s balance sheet shows reliance on both short term and long term debts. In the year 2017, the company’s interest expenses amounted to £630 million that is an indication of a strong reliance on debt to finance operations. As per the end of 2017 financial year, long term and short term debts amounted to £9,330 million and £2,549 million respectively (MorningStar 2017). The company’s ability to secure debts is influenced by its ability to provide reliable financial information.  Lenders rely on the balance sheet, income statement and the cash flow statement when making lending decisions. The balance sheet shows the debt level thus enabling the lender to know whether the borrower’s debt level is sustainable. Companies with a high debt level are risky since they may encounter problems financing the debt (Jonas & Blanchet 2000). The income statement helps the lenders to understand the profitability of a company. According to Obaidat 2007, a company that is making losses may face problems in debt repayment despite having a favourable cash flow position. A lender is only willing to give credit to a borrower whose profitability guarantees the ability to pay.  In other words, interacting with the comprehensive income statement helps the lender to understand the borrower’s long term ability to finance the debt.  Lenders also need the cash flow statement to assess the borrower’s ability to meet current liabilities as they fall due. Cash flow problems have grave impacts in the short run as the company may fail to honour debt obligations when cash-starved.  With the information provided by the three statements, the lender can make informed decisions thus averting the risks associated with advancing credit to borrowers with a poor credit standing. Despite the existing financial reporting standards being directed towards securing the interests of lenders, some loopholes compromise the usefulness of financial information to the lenders. Sometimes these statements may fail to reveal out of ordinary eventualities that can compromise the borrower’s ability to service the debt.

4.2 Government

The government is one of Tesco’s major stakeholders. The UK and other governments where the company carry out its operations rely on the company’s financial information for decision making. The government has an interest in businesses due to tax as well as compliance with the regulatory environment.  Financial statements provide a basis for determining the company’s tax obligation.  The comprehensive income statement shows the business profit and not the taxable profit. A special income statement is prepared to determine the company’s taxable profit thus indicating the tax obligation (Devereux, Liu, & Loretz 2014). This tax obligation is then reflected in the financial statements. Tax authorities require businesses to avail all the financial information needed to support tax calculations.  The International Accounting Standards Board cannot create a universal framework to cater for the interests of all governments since tax systems vary across countries (Devereux, Liu, & Loretz 2014). It is, therefore, the responsibility of respective governments to develop the right accounting framework that meets the specific interest of the government. Tesco operates in twelve countries that have substantially different tax regimes. It implies that a common consolidated financial statement may fail to meet the needs of these governments despite complying with the UK’s tax regulations.

4.3 Suppliers

The suppliers rely on financial information when making decisions. Managing relationships with suppliers is a key business success factor.  One area of managing supplier relationships is providing essential information to support the suppliers in decision making. Such information ought to be relevant, timely and accurate. Financial statements are a source of such information.  Suppliers seek to acquire specific information about a business when deciding on whether to make supplies to the business (Barth, 2006).  The cash position of the company is essential as it determines the buyer’s ability to pay. Tesco receives supplies on short term credit and makes the payment by the suppliers’ conditions.  The cash flow statement helps the suppliers to identify whether Tesco has enough cash reserves to pay for the supplies. An income statement further shows the company’s ability to pay. A loss making company may experience difficulties in paying for the supplies.

4.4 Customers

Customers have interest in a business since they are only willing to engage a seller whose ability to meet their needs is not at stake. Business-to-business relations require a good understanding of the supplier’s ability. Some businesses single source their inputs from a specific supplier and this exposes them to supply chain risks. Unavailability of inputs can have serious impacts on a business, especially where there are switching barriers. Financial statements provide essential information that enables the customers to assess the ability of a supplier. The balance sheet shows the financial position of an organization. A strong balance sheet shows that the company has the financial stamina to address threats (Salehi, Rostami, & Mogadam 2010). On the other hand, a weak balance sheet shows that a supplier is vulnerable and may fail to make supplies on time.   An income statement has important information regarding the ability of an entity to make supplies.  A loss making company may experience difficulties in production due to a shortage of resources. Persistent losses deplete the company’s resources thus posing a threat to operations (Salehi, Rostami & Mogadam 2010). Customers also use the cash flow statement to assess the ability of a supplier. A firm with a troubled cash position is likely to face difficulties when making supplies. On the other hand, a company with a strong liquidity position has an enhanced ability to address operational challenges.

4.5 Investors

Investment decisions have far-reaching making thus require a comprehensive analysis.  This analysis is only possible when there is relevant financial information. Tesco is a publicly traded company that can raise capital from the public.  It implies that members of the public willing to buy the company’s shares and bonds need to be conversant with its short term and long term health.   The balance sheet and income statements form a good basis for understanding the company’s value to the investors. The balance sheet shows the company’s current value as it shows the total assets, liabilities, and equity.  Past and present income statements are used to predict the company’s future value by carrying out trends analysis (Salehi, Rostami & Mogadam 2010). Investors are attracted by companies with a positive future outlook.

5.0 Conclusion

Financial information is of great importance to different classes of stakeholders. The company law requires the board of directors of companies incorporated in the UK to prepare financial statements in line with the existing regulatory framework. These statements provide crucial financial information to external stakeholders thus aiding decision making. The International Accounting Standards Board creates universal standards for guiding the preparation of financial statements. Countries adopt these standards and are at liberty to make accounting policy changes to make the regulatory framework reflect the local conditions. Tesco is a good example of a company whose financial information is used by different classes of stakeholders. The company’s main stakeholders who depend on financial statements include lenders, the government, suppliers, customers, and investors. Financial information needs to have some qualitative characteristics to make it useful. These characteristics include relevance, comparability, consistency, and understandability. The current financial reporting framework cannot guarantee meeting the interests of all stakeholders.  It is technically impossible to create financial statements that address the information needs of all stakeholders.

List of references

Ball, R., 2006, ‘International Financial Reporting Standards (IFRS): pros and cons for investors.’ Accounting and business research, vol.36,no.1, pp.5-27.

Barnes, R., 2011, ‘The great Tesco beauty gamble (the Tesco supermarket chain’s marketing strategy for breaking into the UK beauty services market).’ Strategic Direction, 27(7). 33-78

Barth, M.E., 2006, ‘Including estimates of the future in today’s financial statements.’ Accounting Horizons, vol.20,no.3, pp.271-285.

Chaney, P.K., Faccio, M. & Parsley, D., 2011, ‘The quality of accounting information in politically connected firms.’ Journal of accounting and Economics, vol.51,no2, pp.58-76.

Devereux, M.P., Liu, L. & Loretz, S., 2014, ‘The elasticity of corporate taxable income: New evidence from UK tax records.’ American Economic Journal: Economic Policy, vol.6, no.2, pp.19-53.

Jonas, G.J. &  Blanchet, J., 2000,‘Assessing quality of financial reporting.’ Accounting Horizons, vol.14,no.3, pp.353-363.

MorningStar 2017. ‘Tesco PLC ADR  TSCDY.’,  Retrieved from http://financials.morningstar.com/income-statement/is.html?t=TSCDY&region=usa

Obaidat, A.N., 2007, ‘Accounting information qualitative characteristics gap: Evidence from Jordan.’ International Management Review,vol. 3, no.2, p.26.

Revsine, C., 2012. Johnson. Financial Reporting and Analysis. New Jersey: Prentice Hall.

Salehi, M., Rostami, V. & Mogadam, A., 2010, ‘Usefulness of accounting information system in emerging economy: Empirical evidence of Iran.’ International Journal of Economics and Finance, vol.2,no.2, p.186.

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