How could Tesco lose £250m?

Even by Tesco’s recent run of catastrophic PR own goals in The City, admitting it has discovered a £250m black hole in its finances, the equivalent of more than a third of its first half UK trading profit, is a pretty enormous development.

With leading executives, including UK managing director Chris Bush, John Scouler, its food commercial director, UK finance director Carl Rogberg, and Matt Simister, the head of food sourcing, all believed to have “agreed to step aside”, pending an investigation, Tesco is coming dangerously close to a management meltdown, just weeks into new CEO Dave Lewis’ reign.

So just how on earth did the UK’s biggest retailer get itself into such a mess with its books and what could the revelations mean in the long run?

Tesco has said the issues are down to “accelerated recognition of commercial income and delayed accrual of costs,” which is a type of behaviour familiar to accountants, retailers and suppliers alike.

It is the scale of the figures involved, as well as the sensitive timing, that make it such a damaging story.

“This is effectively timing issues, bringing income forward from future periods and delaying costs to those future periods,” says Bruno Monteyne, senior analyst of European food retail at Sanford C. Bernstein.

“One example in which this could happen is “Tesco commercial director of department X is short his profit target; he/she discusses with a supplier bringing forward a big promotion, funded by the supplier; in return Tesco commits to doing three more new product launches in the next reporting period.“

“Some of this behaviour is acceptable, within limits,” says Crawford Spence, professor of accounting at Warwick Business School. “Firms quite legitimately play around with their revenue and expenses all the time. However, when they do so aggressively, as Tesco appear to have done, this is usually because the firm is under pressure elsewhere. What Tesco appears to have done is push the boat out a bit too far.”

We will have to wait until the now pushed back interims on 23 October - or perhaps even longer - to find out the full details of what has actually happened but already speculation is rife as to what was happening.

“Tesco has been suffering meaningful volume declines for some time, so it is no surprise that suppliers have shifted support to companies that are delivering growth,” says HSBC analyst, David McCarthy.

“Tesco may have been booking promotional rebates based on historic precedent rather than on current volumes. In short, we believe that Tesco’s gross margin has been falling rapidly and that this has been artificially hidden.”

At least nobody can legitimately point the finger at Lewis for this latest chapter in the Tesco circus, however it is hardly a great start to his reign, even if he may emerge in the long run with credit for sorting out all the chaos.

But while it remains to be seen what happened to members of his senior management team-and surely today’s developments only increases the likelihood of a mass clear out- for Tesco it means another elongated period of financial and PR trauma which it can ill afford.

“The scary thing,” according to Monteyne, is that what has been revealed today might not be the end of it.

“Tesco have estimated £250 million for H1 but state they do not know the effect on the full year. We can have no feel at present how big this issue could be.”

“Clearly this is the last thing Dave Lewis needed, although it could have been even worse if this had been discovered next year,” adds Kantar Retail director Bryan Roberts “But he has started the job in a period of absolutely turmoil and I’d be horrified if there are even more skeletons in the cupboard.”

Let’s hope, for Tesco’s sake, there are not.