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Chartered Accountants:

Inappropriate Role as Financial Analysts And Management Consultants?

Pakistan is facing an industrial crisis for the past several years. CA's lack of expertise in fixed income mathematics, international asset returns and competitive strategy will result in failure of sick units revival attempts of the government. Of more general interest is that this problem is prevalent in Bangladesh and we suspect is an important factor in more Asia and emerging markets nations.

Pakistan is in the midst of an industrial, banking and economic crisis. This has resulted from a lot of industrial failures and defaulted loans. Whatever may be the reason for the crisis ranging from inappropriate debt structuring, over invoicing, bad management, over taxation, large government budget deficit, one thing is for certain that bad financial decision have been made. Even if the crisis is entirely the fault of the businessman or the State Bank or the Government of Pakistan one very interesting analysis comes forward.

Wharton Partners has previously identified the inappropriate structuring of debt to be a major cause of industrial sickness. One thing we pointed out was that financial and business analysis done as part of due diligence of project financing or as part of feasibility analysis is quite faulty.

What we have noticed is that a few very well regarded principals of investing were ignored which resulted in the mess we are in. Firstly no one had any idea what the effects of an economic liberalizing policy mixed with a high budget and trade deficit would effect industrial profits. Had any analysis been done of business returns of any other countries one would have come up with the conclusion that the abnormal profits would subside in a hurry especially in the context of a mounting budget and trade deficit which would require financing and hence increase in Rupee interest rates and taxation.

The point being to do this analysis one needs financial experts whose training is in Finance. People who are well versed in the efficient market theory, capital asset pricing models, debt markets, equity markets, international asset allocation and business returns. Similarly to understand competitive pressures it is essential to understand business policy and competitive strategy in detail. This last factor would have resulted in fewer and more efficient textile mills and fewer cement plants, more value added industries and would have resulted in a less serious crisis.

The question then arises who are the financial experts, management consultants, and preparers of feasibility reports? The answer is by and large chartered accountants. Not only do they operate as accountants and maintain books and conduct audits but are regarded as both financial experts and management consultants. Their role as financial experts and as management consultants is extremely inappropriate.

While CA's were acting as the financial experts and management consultants and were responsible for making feasibility reports, something went drastically wrong. So much of the industry went sick and the banking sector close to disaster. The question arises, if there was a very serious debt structuring problem in Pakistan, why did not the financial experts catch it. Here if we think about it lets look at who is considered a financial expert in Pakistan or more specifically a debt expert. By this I mean, when there is talk about reviving the sick industries or the banking sector who are sought for their opinion about the problem. Primarily the Chartered accountants. But chartered accountants are supposed to be primarily accounting book keepers and auditors. Their training does not go into debt financing in detail nor are they made aware about international asset returns.

So who are the financial experts and management consultants in the USA? It is interesting to look at the perspective of a typical Harvard or Wharton Business School Graduate. His training is very general he would understand the basics of Accounting, Finance, Management, Marketing, Statistics. He would be concerned about competitive advantages and how businesses he analyzes would be effected by changing government policy. If he concentrates in international finance or fixed income finance, he would understand the issues. Further training as a CFA would entail being trained in such areas as fixed income securities (bonds), equity markets and other diverse areas of finance in detail. Thus a CFA (Chartered Financial Analyst) is more prototypical of a qualified financial expert than a CPA. And this explains why there are both CPA's and CFA's (and financial analysts) in the USA each having expert but very different roles. As far as management consulting is concerned, top firms like McKinsey & Co. hire people from the top business schools from America.

On the contrary the CA's wear all these different hats. The typical CA in Pakistan is just not trained for such analysis. Sure the business environment in Pakistan is extremely volatile and very few business graduates from even the top US Schools would be able to effectively model and predict what to expect. A CA in Pakistan, well trained in accounting as he may be, is inadequate in terms of his expertise in debt structuring, strategic analysis etc., which a CFA or a top business school graduate would be. Granted, the Accounting expertise of the chartered accountant may be quite substantial.

The fact is that project financing decision taken in Pakistan have been detrimental for Pakistan's economic future. A large part of this is due to a lack of proper research into the hidden competitive advantages that Pakistan holds in the supply of products. This has been due to a lack of vision on part of the entrepreneur, banker, and the chartered accountants responsible for preparing feasibility reports. This has, for example, resulted in the stagnation of the engineering and value added industry in Pakistan. What is worse is the implications of this to the future of industrial revival in Pakistan.

We believe the current approach for reviving industry based on State Bank and the Sick units committee has a high probability of failure. The primary reason for the failure is that a number of crucial issues have been missed by the committee. A big reason for the mishap as well as the industrial sickness in the first place was due to the inappropriate role of chartered accountants. Their inclusion as financial experts and management consultants is inappropriate. Their being made to act as such has resulted in flawed analysis and extreme detriment to the Banking system and the industry. This crucial lack of expertise include the following.

1. Insufficient training in competitive analysis from the point of view of industrial returns projection.

2. Lack of understanding of international asset returns. Not understanding the relevance of international asset returns.

3. Lack of training in fixed income (debt) mathematics and finance. These factors are crucial in the development of the banking and industrial crisis

Chartered Accountants by training are not trained in the above mentioned areas which are absolutely crucial for optimal capital resource allocation in form of investment. It is interesting to note that ACCA qualified chartered accountants are to a much larger extent trained in competitive analysis. Also the State Bank, the chief regulatory body for the banks lacks the above mentioned expertise. The whole project appraisal process must be rethought in order to avoid a complete industrial and consequently economic collapse. If this is not done, the sick unit revival plans will fail.

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Investment Implications

• Be extremely careful about analysis you get in Pakistan and Bangladesh in particular keeping in view the areas we have identified as areas of weaknesses.
• Be extremely careful regarding generic systematic problems arising in these countries.
• Contact Wharton Partners for a test for your financial analysis firm and also for getting guidelines of exposing weaknesses in analysis you get prepared.
• Look out for similar problem arising in other emerging markets countries.

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Significance of the Research

A few reasons why it is important to understand the significance of this research piece is to understand that in countries like Pakistan, the entire establishment including the Central Bank, Ministry of Finance, Bankers, Chamber of Commerce and Businessman were completely unaware about this problem for several decades. No economic revival package can work without realizing this factor. Hence expect bad investment opportunities in countries where this problem exists. A devastating debt structuring problem existed in Pakistan for decades without any of the financial experts finding it until Wharton Partners uncovered this problem in 1996.

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