CAF-6-ST-2023.pdf

CAF - 6 MANAGERIAL AND FINANCIAL ANALYSIS THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN i Second edition published by The Institute of Chartered Accountants of Pakistan Chartered Accountants Avenue Clifton Karachi – 75600 Pakistan Email:...

CAF - 6 MANAGERIAL AND FINANCIAL ANALYSIS THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN i Second edition published by The Institute of Chartered Accountants of Pakistan Chartered Accountants Avenue Clifton Karachi – 75600 Pakistan Email: [email protected] www.icap.org.pk © The Institute of Chartered Accountants of Pakistan, May 2023 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, without the prior permission in writing of the Institute of Chartered Accountants of Pakistan, or as expressly permitted by law, or under the terms agreed with the appropriate reprographics rights organization. You must not circulate this book in any other binding or cover and you must impose the same condition on any acquirer. Notice The Institute of Chartered Accountants of Pakistan has made every effort to ensure that at the time of writing, the contents of this study text are accurate, but neither the Institute of Chartered Accountants of Pakistan nor its directors or employees shall be under any liability whatsoever for any inaccurate or misleading information this work could contain. ii THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN  TABLE OF CONTENTS CHAPTER PAGE Chapter 1 Political environment and business 1 Chapter 2 Economy and the business perspective 9 Chapter 3 Social and legal environment on business 19 Chapter 4 Information and communication technologies 31 Chapter 5 Technological disruption and business environment 43 Chapter 6 Comprehensive examples of Chapter 1 to 5 53 Chapter 7 Competitive forces 59 Chapter 8 Internal analysis 101 Chapter 9 Ethical decision making models 133 Chapter 10 Sources of finance 147 Chapter 11 Cost of finance 173 Chapter 12 Identifying and assessing risk 199 Chapter 13 Financial risk management 217 Chapter 14 Budgeting 235 Chapter 15 Working capital management 293 Chapter 16 Introduction to project appraisal 309 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN iii iv THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN  CHAPTER 1 POLITICAL ENVIRONMENT AND BUSINESS IN THIS CHAPTER 1. Introduction 2. The spectrum of political ideologies 3. Impact of Political ideologies on businesses 4. Interaction between businesses and the government THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 1 CHAPTER 1: POLITICAL ENVIRONMENT AND BUSINESS CAF 6: MFA 1. INTRODUCTION Politics in the world started since the establishment of society after agricultural revolution. The ideas and implementation of politics has been evolving since then according to the experiences of individual society and their needs. Today we cannot find a single definition of politics which can satisfy the intrinsic values held by individual and society. To Vladimir Lenin, "politics is the most concentrated expression of economics. The definition of politics varies from person to person depending on their concept of society. Sir Bernard Rowland Crick, prominent British political thinker defines it as, “"politics is a distinctive form of rule whereby people act together through institutionalized procedures to resolve differences, to conciliate diverse interests and values and to make public policies in the pursuit of common purposes." Politics is focal point of society that has direct or indirect impact on the state, society, individual, economy and government Business activity is always dependent on the political policy and decision making. It is the prerogative of the government to adopt or discard policies conducive for business. The political setup in any country depends upon various factors such as,  Political ideology of the ruling political party, and of the people in the society. There are several political ideologies propounded in the previous three centuries that govern the modern world. All of them have their origin in Europe.  Existing laws and regulations  Socio-religious norms and constraints.  Political opposition and their economic agendas. In today’s world various elements of the society such as business and politics have become integrated, and they are interdependent in various ways on each other. For any business executive it has become imperative to have an understanding of this complex relationship. The major indicators of the prospective policy making are visible beforehand and business managers must be cognizant of it. To become an effective business manager, one should take into consideration the political environment for business, and then capitalize on the opportunity available and mitigate potential risks. 2 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN CAF 6: MFA CHAPTER 1: POLITICAL ENVIRONMENT AND BUSINESS 2. THE SPECTRUM OF POLITICAL IDEOLOGIES Communism Conservatism Fascist Capitalism Extreme Left Liberals Left wing Right Wing Extreme Left Centre Moderates Radicals Democratic Laissez Faire Dictatorial Democracy Dictatorial Socialism Democratic Capitalism socialism Capitalism Reactionaries  All means of  Most and  They want  Free market,  No individual production must important means change but not at open competition freedom. be in the hands of of production in the cost of  Elitist and  Authoritarian state the hands of state tradition. oligarchy (rule by rule. with few  No private  State must play the few rich and exceptions are  Private property property the role of powerful) allowed. as prescribed by guardian for all.  Distribution of  Law favors the the ruling regime.  Private property state earnings on  Individual elite. is allowed.  Extreme the basis of the freedom is  Maximum private inequalities. need of people.  It recognizes the recognized. property with distinction  Protection of  Production by the  Full religious least ownership amongst people national interest state industries freedom. of means of based on their at all costs. would be based production by ability and their  Private property on the needs of state.  Implementation contribution. is allowed. people of ideology  Maintain ‘status  Distribution of  Ownership of through any  Egalitarian, class quo’. output amongst private and means possible, less society people should be public means of  Attainment of including where everyone based on their production needs national or state violence. has equal input. to be balanced. goals by any material.  This system does means possible,  Challenges ‘status  They believe in not allow  No individual including quo’. international dissenting freedom in amending the cooperation for opinion. making choices  The system laws around it. the benefit of all for consumption. believe that the  Hitler/Mussolini/ however they  Individual people are the Franco  It is also recognize liberties are responsibility of comprehensive their national recognized with  Nazi Germany, the state, and it political system interests. exceptions. Fascist Italy and needs to regulate which has its own Spain. business through  Slow social  Religious practice economic system. laws to protect change. in all forms is  There is no room masses. allowed.  Canada for ‘organized  Religion is  Large religion’ in  J.S.Mill/Keynes/F. allowed in this corporations can communism. D.Roosevelt. system flourish in this However system and individual  They favor charge their religion is change through consumers as supported in peaceful means. much as they can. some form. They  Everyone is equal consider religion in-front of the as ‘opium of law. masses.’ THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 3 CHAPTER 1: POLITICAL ENVIRONMENT AND BUSINESS CAF 6: MFA Communism Conservatism Fascist Capitalism Extreme Left Liberals Left wing Right Wing Extreme Left Centre Moderates Radicals Democratic Laissez Faire Dictatorial Democracy Dictatorial Socialism Democratic Capitalism socialism Capitalism Reactionaries  Communists want  Implementation  There is a change through of ideology tendency of any means through social suppression and possible including change. oppression by violence. majority.  Major  Stalin/Lenin characteristics,  Attainment of collectivism, National Interest  Soviet Union economic over equality, social international service, cooperation. nationalization.  Power Politics.  Fabian  Key terms of  Sweden characteristics; individualism, private ownership, self- interest, open competition, privatization, not much protection from the system,  Friedman/Hayed /Reagon/Thatche r  United States 4 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN CAF 6: MFA CHAPTER 1: POLITICAL ENVIRONMENT AND BUSINESS 3. IMPACT OF POLITICAL ENVIRONMENT ON BUSINESSES Many political decisions taken by ruling party have serious economic and business implications. In the past communists and other leftists favored state control and were against private capital, particularly foreign investment and international control over local business and property. On the other hand USA allows and encourages private ownership (for reference see the previous chart). Important economic policies such as industrial policy, policy towards foreign capital and technology, fiscal policy and foreign trade policy are often political decisions. Therefore, a business manager has to be familiar with the ideologies and past approaches of key political parties to analyze possible future policies of existing and forthcoming ruling parties. The goal of any government is to run the country according to their respective ideology for the attainment of economic prosperity and political stability The following are several ways in which political factors are affecting business in today’s world, or can affect, as well as some of the ways to prepare for – and mitigate – the associated risks. 3.1. Government spending The direction of state spending is based on its inherent political ideology. Such as government inclined towards left would spend on public sphere, free health, education for all, services, and welfare of all. On the contrary right- wing state would spend more on defense, international security, alliances, expansion of influence over other states (neo-imperialism) etc. 3.2. Taxation Tax is the mechanism through which state earns for spending and building resources. Political ideologies may propose different sorts of taxation. Tax policies can have a massive effect on a business’ overheads and profit margins. These policies are often used to promote political ideologies of ruling party. These policies may be used:  to reduce income of individuals and companies and thus reduce private expenditures  to provide resources for public expenditures (on roads, highways, public schools, colleges, hospitals or even parks and playgrounds)  to exercise control over the private sector investment  to improve country’s business competitive position As an example, the Republican Party in the US and the Conservative Party in the UK are a clear illustration of parties who favour tax cuts as a route to helping businesses grow. A good state is the one which collects tax under its prescribed laws from all taxable individuals and business. Specially for direct taxes that are paid by the citizens of the state directly based on their incomes and wealth, if the state fails to broaden the tax net to all taxable persons and businesses, then it creates disparities and frustration in the hearts of tax payers and the state is ultimately forced to go for indirect tax which is equal on all. Pakistan is facing this problem for past few decades and consecutive governments are unable to broaden the tax net successfully. 3.3. Economic policies Different political parties or individuals enact different policies to guide national economy based on their own economic ideologies and agenda. This means that politics can impact different sectors in varying ways. A pro- agriculture political approach may not be able to pay attention to other sectors. An ideology relying on non- agriculture sector for economic growth may manage economy that is not conducive for agriculture sector. 3.4. Labor Laws Political parties are often vocal on their stances regarding minimum wages, insurance requirements, labor- related taxes and regulation on the terms of employment. Any change in labor laws can mean a change in expenses for a business, and these expenses can be significant for small businesses. Over regulation may impact ease of doing business. Today local labor laws are also affected by international labor regulations. For example, Western developed economies do not allow imports from such countries who do not ensure labor health and safety policies and child labour. The regulations are so strict that the buyers from such countries send their inspectors on regular basis to exporting partners for inspection and certifications. THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 5 CHAPTER 1: POLITICAL ENVIRONMENT AND BUSINESS CAF 6: MFA 3.5. International relationship and policies International relationship and policies are one of the important part of political mindset. An ideology that support good international relation and welcomes foreign investments will have direct impact on sustainability of local businesses. On the other hand, a protectionist policy may have different impact. We live in an increasingly interconnected world where even small businesses have global supply chains.  Example: Effects of a socialist regime on the business and economy Mr Z. A. Bhutto was avowedly committed to socialist economy, which envisaged the state as the major player on the economic scene. Therefore, after attaining power he started a nationalisation programme. In the first phase of the programme, a number of basic industries were nationalised. In the second phase, the state took control of financial institutions including banks and insurance companies. And in the third and final phase, rice-husking units were nationlised. (PPP first government 1971-77 nationalised industries due to their believe that blatant private investment during the Ayub Khan era (1958-69) has created economic disparity and accumulated all the capital of the country in the hands for few). The nationlisation policy of the Bhutto government was seen by many economists as a serious threat to the efforts for economic development during 1960s and resulted in economic inefficiency and mis- allocation of resources. Undeniably economic growth slowed in the wake of nationalisation. This is corroborated by the fact that during 1960s, Pakistan's economy grew on average at 6.8 per cent per annum, during 1970s, growth rate fell to 4.8 per cent per annum on average. It is also true that most of the nationalised units went into loss, because decisions were not market-based. However, there is a counter argument that rapid economic growth is not the only macro-economic objective of a government. The government has also distributional objectives so as to reduce economic disparities. During 1960s rapid economic growth was accompanied by concentration of resources in a few hands. In today’s evolved environment and ideologies an all-out nationalization is far from future scenario. But a business manager may expect some kind of governmental intervention if a party is expected to or come to power with similar political ideology. 6 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN CAF 6: MFA CHAPTER 1: POLITICAL ENVIRONMENT AND BUSINESS 4. INTERACTION BETWEEN BUSINESSES AND THE GOVERNMENT Entrepreneurs and business people are not entirely powerless, especially in modern democracies. Pressure groups and lobbying are two ways in which government decisions and policies are managed by business owners. Political parties need the support of businesses – especially larger, influential ones – both in the form of votes as well as contributions to economy, reduction of unemployment and party funding for political activities This may create a situation where sector-biased decisions can be obtained adversely impacting other sectors. A business manager should keep an eye on political parties influenced by their supporters from business community and pressure groups of businesses. Some of the ways businesses pursue and protect their interests with the political setups are discussed below 4.1. Financial incentive strategy Businesses may gain a position where they can pursue a financial incentive strategy to use their economic leverage to influence public policymakers. Economic leverage occurs when a business uses its economic power to threaten to leave a city, state, or country unless a desired political action is taken. Economic leverage also can be used to persuade a government body to act in a certain way that would favor the business. 4.2. Promoting a Constituency-Building Strategy The businesses may influence the political environment by seeking support from organizations or people who are also affected by the public policy or who are sympathetic to business’s political position. Its objective is to shape policy by mobilizing the broad public in support of a business organization’s position. Firms use advocacy advertising, public relations, and building coalitions with other affected stakeholders. Some of the influencing approaches are as follows: Stakeholder Coalitions Businesses may try to influence politics by mobilizing various organizational stakeholders— employees, stockholders (shareholders), customers, and the local community—to support their political agenda. If a political issue can negatively affect a business, it is likely that it will also negatively affect that business’s stakeholders. Often, businesses organize programs to get organizational stakeholders, acting as lobbyists or voters, to influence government officials to vote or act in a favorable way. Advocacy Advertising A common method of influencing constituents is advocacy advertising. Advocacy ads focus not on a particular product or service, like most ads, but rather on an organization’s or company’s views on controversial political issues. Advocacy ads, also called issue advertisements, can appear in newspapers, on television, or in other media outlets. Trade Associations Many businesses work through trade associations —coalitions of business organizations in the same or related industries—to coordinate their efforts in promoting common interests of the industry, such as the Federation of Pakistani Chambers of Commerce & Industry. Other examples of trade associations include the Overseas Investors Chambers of Commerce and Industry (OICCI), American Business Council (ABC), the All Pakistan Textile Manufacturers Association (APTMA), or the Pakistan Automotive Manufacturers Association (PAMA). The associations represent numerous businesses with millions of trade potential and include businesses of all sizes, sectors, and regions. The associations also organize to publish widely circulated magazines and newsletters to broadcast its developments and other messages. There are various industrial associations that act in unison upon certain political and public policy initiatives. Such as the All Pakistan Textile Mills Association (APTMA) voices its concerns over the load shedding of electricity and hike in industrial tariffs since textile production and exports have been seriously affected in the last decade due to energy shortages. Moreover, organizations like the Overseas Investors Chambers of Commerce and Industry (OICCI) is a body which is represented by all private companies and businesses to channel its concerns and interests collectively to make an impact and promotion of business friendly policies so that their investment in the country is put to good use. THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 7 CHAPTER 1: POLITICAL ENVIRONMENT AND BUSINESS CAF 6: MFA 4.3. Managing the Political Environment - the Public Affairs Department At an operational level, in many organizations, the task of managing political activity falls to the department of public affairs or government relations. The role of the public affairs department is to manage the firm’s interactions with governments at all levels and to promote the firm’s interests in the political process. The creation of public affairs units is a global trend, with many companies in developed countries initiating sophisticated public affairs operations. The typical public affairs executive spends most of the day direct lobbying with federal or state politicians, hosting visits by politicians to the company’s locations, or attending fund-raising activities. 8 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN  CHAPTER 2 ECONOMY AND THE BUSINESS PERSPECTIVE IN THIS CHAPTER 1. Economic environment 2. Economic indicators THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 9 CHAPTER 2: ECONOMY AND THE BUSINESS PERSPECTIVE CAF 6: MFA 1. ECONOMIC ENVIRONMENT The economic environment refers to external factors and the broader economic trends that can impact a business. Economic environment can be classified into microeconomic and macroeconomic environment. Microeconomic environment relates to consumers behaviour, market environment, competition in the market and demand and supply forces prevalent in the market place. Macroeconomic relates to broad economic factors that affect the entire economy and all of its participants, including individual business. The focus of this chapter is macroeconomic factors that are analysed on the basis of economic indicators. 10 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN CAF 6: MFA CHAPTER 2: ECONOMY AND THE BUSINESS PERSPECTIVE 2. ECONOMIC INDICATOR An economic indicator is a type of economic data on a macroeconomic level, that helps in evaluating the overall economy of a country. Economic indicators can be classified as follows:  Leading economic indicators  Coincident economic indicators  Lagging economic indicators Leading economic indicators These indicators are used to forecast at what stage the economy will be in, at some time in the future. These indicators, in particular give an indication for whether a peak or trough will be reached in the following 3-12 months. Examples include:  Stock market index  Index of business confidence  Manufacturers’ new orders  New building permits for private housing  The money supply Coincident economic indicators These indicators are events and measures that occur at the same time as a peak or trough occurs. These are used by governments to assess at what stage in the cycle the economy is in. Examples include:  Gross Domestic Product (GDP)  Number of people in employment  Industrial production  Personal incomes  Manufacturing and trade sales Lagging economic indicators These indicators are used to assess whether an economy has reached a peak or trough 3-12 months after it would have occurred. Examples include:  Consumer Price Index (i.e. level of inflation)  Unemployment  Interest rates  Average income  Balance of Trade THE ECONOMIC CYCLE The economic cycle is a term used to describe how, in general, the national income of a country increases or decreases from one year to the next. THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 11 CHAPTER 2: ECONOMY AND THE BUSINESS PERSPECTIVE CAF 6: MFA When national income increases from one year to the next, there is economic growth. When national income decreases from one year to the next, there is economic recession (or in extreme cases, economic decline). An economic cycle consists of several years of economic growth, with national income each year being higher than in the previous year, followed by economic recession, which is a period of years during which national income is falling. Government economic policy usually tries to achieve continued economic growth, but if recession becomes unavoidable, policy is then aimed at making the recession as short and as minor as possible. Business managers need to be cognizant of the stage of economic cycle in order to make and implement effective business strategy. For example, in a period of economic depression, it is probably not good idea to launch a new product STOCK MARKET INDEX The stock market is considered as one of the leading indicators of where the economy will be in the near future. The performance of a stock market is measured through stock market index. Stock market indices portray investors confidence in the capital market that provide the basis for flow of capital for businesses. High stock indices therefore reflect potentially positive business prospects. The stock market is considered as one of the leading indicators of where the economy will be in the near future. The performance of a stock market is measured through stock market index. Stock market index is the index of the market capitalization of a section of the stock market. Market capitalization is the market value of a publicly traded company's outstanding shares. It is equal to the share price multiplied by the number of shares outstanding. It measures a company’s worth on the open market, as well as the market's perception of its future prospects. It reflects what investors are willing to pay for its stock. It is a tool used by investors to describe the market and to compare the return on specific investments. Market capitalization could be based on:  Free-Float  Full-cap Free-Float means proportion of total shares issued by a company that are readily available for trading at the Stock Exchange. It generally excludes the shares held by controlling directors, sponsors, promoters, government and other locked-in shares, not available for trading in the normal course. Full-cap includes all of the shares issued by a company. Stock Exchange Indices Stock exchange indices are leading indicators that group companies in a specific category, sector or performance. Indices are calculated through market capitalization. Some key indexes relevant in the context of the Pakistan Stock Exchange are as follows: KSE-100 index This is the most recognized index of Pakistan Stock Exchange which includes the largest companies on the basis of market capitalization. The index represents 85% of all the market capitalization of the exchange. It is calculated using Free Float Market Capitalization methodology. The KSE100 has a base value of 1000 as of November, 1991. All Share Index It consists of all listed companies on PSX based on Full Cap methodology. 12 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN CAF 6: MFA CHAPTER 2: ECONOMY AND THE BUSINESS PERSPECTIVE Stock Exchanges Indices and Business Decisions The stock market's movements can impact companies in a number of ways. The rise and fall of share price values affects a company’s market capitalization and therefore its market value. Businesses also consider stock performance in decisions related to issue of shares. If a stock is performing well, a company might be encouraged to issue more shares because they will be able to raise more capital at a higher value. The market value of a company is also an important factor when considering mergers and/or acquisitions. Companies may hold shares as cash equivalents, fall in value of shares can lead to funding problems. On the other hand, increase in the stocks’ value of a company may generate interest for new products or businesses. INFLATION Inflation is the increase in price levels over time. The rate of inflation is measured using one or more price indices or cost indices, such as a Consumer Price Index (CPI) or a Retail Price Index (RPI) or an Index of Wages Costs. Businesses are affected by inflation, because inflation means that they have to pay more for resources, such as materials and labour. They will try to pass on their extra costs to their customers, by raising the prices of their own goods and services. Individuals have to pay higher prices for goods and services, so they need more money to pay for them. If they are employed, they might demand higher wages and salaries. The ‘inflationary spiral’ can go on indefinitely, with increases in materials and wages pushing up prices of finished goods, which in turn leads to higher wages and materials costs. It is also recognised that the rate of inflation is affected by inflationary expectations. This is the rate of inflation that businesses and individuals expect in the future. Inflationary expectations affect demands for wage rises, and decisions by businesses to raise their prices. Implications of high inflation and inflationary expectations for the national economy Inflation also has implications for the national economy and economic growth. Increases in national income are the result of two factors:  an increase in the ‘real’ quantity of goods and services produced and the ‘real’ spending on goods and services, and  increases due to higher prices and costs. It is possible for measured national income to increase when the real economy is in recession. For example, suppose that measured national income increases from one year to the next by 3% but inflation during the year was 5%. This indicates that the ‘real’ economy has gone into recession, and is 2% lower. Experience has shown that when the rate of inflation is high, and inflationary expectations are high, the ‘real’ economy is likely to stagnate or go into recession. Inflation, however, may serve as an incentive for producers to produce more seeing higher prices and profits, which results in increasing the real output and income. Economists therefore usually hold that some inflation is necessary to induce economic growth. A government might therefore take the view that some inflation is unavoidable (although in some countries there has been deflation – a fall in retail prices). However, the rate of inflation and inflationary expectations should be kept under control, to give the ‘real economy’ an opportunity to grow. Implications of inflation Although some inflation might be unavoidable, it has unfortunate social and economic implications, because it results in a shift of economic wealth. THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 13 CHAPTER 2: ECONOMY AND THE BUSINESS PERSPECTIVE CAF 6: MFA In a time of inflation, debts such as bank loans fall in real value over time. Borrowers gain from the falling real value of debt. At the same time, lenders and savers lose because the value of their loan or savings falls. For example, an individual with cash savings might be earning 3% after tax when inflation is 5%: if so, he is losing 2% in real terms each year. The effect of inflation is therefore to shift wealth from savers and lenders to borrowers. Another effect of inflation is to reduce the real value of households on fixed incomes or incomes that rise by less than the rate of inflation each year, such as many pensioners. The rich might get richer (because their income is often protected against inflation, for example by salary rises) whilst the poor get poorer. A quick glance on inflation rates in Pakistan According to the Pakistan Bureau of Statistics (“PBS”), CPI inflation surged by 9.70% on a year-on-year basis in June 2021 vs. 8.60% last year. The inflation rate remained high throughout the fiscal year 2020-21, it reached a peak of 11.1% in the month of April 2021 and achieved a significant dip of 9.7% in June 2021. INTEREST RATES Interest rate is the amount of interest charged by the lender on the sum borrowed or the amount paid by the bank on the amount deposited. Interest rates are expressed as annual percentages. Although interest is generally defined as the cost of using money, interest rate as a macroeconomic variable usually refers to the regulated interest rate set by the monetary authorities (The State Bank in Pakistan) to be observed by the commercial banks for all their dealings. This is the base rate on which all other market interest rates like those offered by banks to their depositors and charged from lenders depend. The Karachi Interbank Offered Rate, commonly known as KIBOR, is a daily reference rate based on the interest rates at which banks offer to lend unsecured funds to other banks in the Karachi wholesale (or "interbank") money market Increase in interest rates An increase in interest rates will discourage investment as it would be more difficult for companies to earn an adequate return on projects. However, it might encourage people to save, thus resulting in availability of more funds for investment which would put downward pressure on interest rates some time in future. Consumption would fall for a number of reasons:  High interest rates encourage people to save. This would put a downward pressure on consumption.  High interest rates would result in lower disposable income for those people with loans and mortgages.  High interest rates make it more expensive to borrow. This would reduce consumption. For example, the banking sector's profitability increases with an increase in interest rate. Institutions in the banking sector, such as retail banks, commercial banks, investment banks, insurance companies and brokerages have large cash holdings in the form of customer balances and other business activities. Increases in the interest rate directly increase the return on this cash and the proceeds directly add to earnings. The benefit of higher interest rates most significantly impacts brokerage houses, commercial banks and regional banks. Another example could be taken from the textile sector. An increase in interest rate has increased the cost of doing business in the industry which makes it less competitive in the international market especially when compared to countries like Bangladesh and Vietnam which are taking a larger share of textile exports. Due to a fall in demand for exports and domestic sales, the industry could decide to lay off some of the workforce which would give rise to unemployment. Due to high interest rate, financing cost also increases significantly and hinders investments in expansion of production facilities or upgradation of technology and equipment. An increase in mark-up rates can also cause defaults on loans and their servicing by the textile industry. 14 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN CAF 6: MFA CHAPTER 2: ECONOMY AND THE BUSINESS PERSPECTIVE Due to the resulting decrease in the overall import bill, a lowered interest rate will allow for greater capital investments, eventual job creation and improvements in technology, research and development. Decrease in interest rates A decrease in interest rates would encourage investment as it would be easier for firms to earn an adequate return on projects. However, it might discourage saving, thus resulting in a reduction in funds available for investment which would put upward pressure on interest rates. Consumption would rise for a number of reasons:  Low interest rates discourage saving.  Low interest rates result in higher disposable income for those people with loans and mortgages.  Low interest rates make it less expensive to borrow. This would increase consumption. A quick glance on interest rates in Pakistan during 2020-21 (Source: SBP’s quarterly report) The SBP’s Monetary Policy Committee decided to keep the policy rate unchanged at 7 percent during the third quarter of 2021 to provide support in the domestic economic recovery and due to uncertainty stemming from the third wave of Covid. A sizable expansion in fixed investment loans and consumer financing, especially auto-financing was witnessed, primarily, due to the low interest rate environment. UNEMPLOYMENT When there are many people who are unwillingly out of work, this means that there are not enough jobs for the people who want them. Business organisations could take on more labour if they wanted to, but they choose not to. When there is economic recession and demand for goods and services is falling, many firms will make some employees redundant because their profits are falling and some aspects of their business are no longer profitable. Impact of unemployment The impact of unemployment on economy can be explained as follows: High levels of unemployment are unwelcome in an economy because:  individuals who want jobs cannot get them (and high unemployment is damaging to society and the welfare of the people)  economic growth is less than it could be: if the unemployed individuals could be given work, output in the economy would increase and there would be economic growth. An additional problem of high unemployment might be due to shortage of skilled labour. As the technological complexity of industry increases, the demand for low-skilled jobs might fall and the demand for skilled labour rises. Such a shortage of skilled labour can be managed through:  better standards of education  more training  if necessary, moving jobs to other countries where there is a better supply of skilled labour. Unemployment and business decisions Unemployment means that an economy is not making full use of the workers that are available. The economy will not grow as quickly as it could and it may start to slow down. This downturn in economic activity will directly affect businesses. THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 15 CHAPTER 2: ECONOMY AND THE BUSINESS PERSPECTIVE CAF 6: MFA High unemployment will mean that many households will have less income. For many businesses, this will result in lower sales as people reduce spending. However, the demand for some products and services will still increase because consumers would swap to cheaper alternatives. For example, supermarkets’ own-brand products will be sold more as they are considered lower priced than branded alternatives. Also people might prefer to buy locally produced goods rather than imported ones and local companies might have to increase production due to higher demand. Businesses that benefit when there is an increase in unemployment will also have more workforce available to choose from, if they need more staff in periods of higher sales/demand. Businesses looking to recruit people may also be able to offer relatively lower pay and still attract new staff. Some businesses may benefit from unemployment also as more workforce is made available to choose from, in periods of higher sales/demand relatively at a lower pay and still attract new staff. Fiscal policy Fiscal policy is government policy on revenue (taxation), spending and government borrowing. The main objective of fiscal policy is to enhance and sustain economic growth by way of reducing unemployment and poverty in the country. Government spending is a part of national income and includes expenses on wages to government employees, development expenditure, health, education, defence etc. In order to spend, a government must raise the money in tax, and borrow any excess of spending over tax revenue. A government might also try to encourage investment by the private sector (companies). It can try to do this by offering special tax incentives or subsidies (cash payments) to encourage private sector investment in specific sectors, such as the state transport system, and state schools and hospitals. BALANCE OF PAYMENTS The balance of payments (BOP) measures the financial transactions made between consumers, businesses and the government in one country with others. It is calculated by adding up the value of all the goods that are exported (i.e. sold to other countries) and imported (i.e. bought from other countries). It is made up by a combination, in a country, of:  the current account  the capital account  official financing account For every country: Surplus or deficit on trade in goods and services = Net outflow or inflow of capital For example, if a country has a surplus of $10 billion on its foreign trade in goods and services; it also transfers $10 billion in capital flows to other countries. Similarly, a country with a deficit of $25 billion on its trade in exports and imports receives net transfers of $25 billion in capital. The balance of payments data is an important indicator for investment managers, government policymakers, the central bank, businessmen, etc. Businesses use BOP to examine the market potential of a country, especially in the short term. A country with a large trade deficit is not as likely to import as much as a country with a trade surplus. If there is a large trade deficit, the government may adopt a policy of trade restrictions, such as quotas or tariffs and manufacturing businesses who are dependent on imports, for example, to import machinery and equipment would experience an increase in costs. Also, businesses that import raw material for their products would also have to pay higher due to tariffs or experience shortage due to quotas and hence make adjustments to their pricing and inventory decisions. 16 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN CAF 6: MFA CHAPTER 2: ECONOMY AND THE BUSINESS PERSPECTIVE For example, if a government faces a negative balance of payments, it would ideally promote industries focused on export such as textile and related value added products. On the other hand, it would curb imports of luxury items such packaged food, chocolates or confectionary. Moreover, an incentive for the automobile manufacturers to invest in local manufacturing would reduce pressure on imports by reducing the inflow of vehicles manufactured abroad. Some governments may also go to the extent of protection of local manufacturers through import tariffs to support the automobile sector and improve large trade gaps. GROSS DOMESTIC PRODUCT Gross domestic product is a monetary measure of the market value of all the final goods and services produced within a country in a specific time period. The GDP figure can be expressed as the GDP per capita (i.e. the GDP per head of population) in order to compare different economies. Formula: Gross domestic product GDP = C + I + G + (X - M) Where: C = amount of consumption in the economy I = amount of investment in the economy G = amount of government spending in the economy X = amount of exports from the economy M = amount of imports into the economy In other words, the GDP is the total output from all of the sectors of an economy:  Primary sector (agriculture, mining etc.)  Secondary sector (manufacturing and construction; and Tertiary sector (services) GDP per capita is often considered an indicator of a country's standard of living, though it is not a measure of personal income. GDP does not include services and products that are produced by the nation in other countries. In other words, GDP measures products only produced inside a country’s borders. The GDP for a particular year is measured by two ways, nominal GDP and real GDP.  Nominal GDP is the value of GDP evaluated at current prices in a specific time period, this includes the impact of inflation and is normally higher than the GDP.  Real GDP is an inflation adjusted value of GDP. It expresses the value of goods and services produced in a country in base-year prices. Since it is an inflation-corrected figure so it is deemed to be an accurate indicator of economic growth. As reported in SBP’s quarterly reports on Pakistan’s economy, the recovery in Pakistan's economy gained further traction in the third quarter of FY21. The growing momentum over the three quarters of FY21 is reflected in the provisional estimates of GDP growth of 3.9 percent for the full year. Compared to last year's contraction of 0.5 percent, the recovery this year was mainly achieved through a turnaround in large scale manufacturing (LSM) industry, and the services sector, particularly the expansion in the wholesale and retail trade segment. In the agriculture sector, growth in wheat, rice, maize and sugarcane, all expected to achieve record or near record high output this year, offset the decline in cotton production. THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 17 CHAPTER 2: ECONOMY AND THE BUSINESS PERSPECTIVE CAF 6: MFA Changes in Economic Indicators and Some Common Business Responses Change Consumers Businesses Higher unemployment May spend less, as fewer May lower prices in order to encourage rate people are earning people to buy Lower unemployment May increase their spending, May increase prices as demand increases rate as more people are in work Increased interest rates May spend less, as they are May reduce products’ sizes but leave the price encouraged to save unchanged, increasing the profit margin. This is sometimes called ‘shrinkflation’ Decreased interest rates May spend more, as there is May launch bigger versions of products to less incentive to save charge higher prices Decreased value of pound May spend more on imported May target new domestic markets for their sterling (exchange rate) goods, as they are relatively products to attract new customers cheap Increased value of pound May spend less on imported May target new international markets for sterling (exchange rate) goods, as they are relatively their products as exports are cheaper more expensive 18 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN  CHAPTER 3 SOCIAL AND LEGAL ENVIRONMENT OF BUSINESS IN THIS CHAPTER 1. Social factors and their influence on business 2. Legal environment affecting business 3. Legal environment and ease of doing business THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 19 CHAPTER 3: SOCIAL AND LEGAL ENVIRONMENT OF BUSINESS CAF 6: MFA 1. SOCIAL FACTORS AND THEIR INFLUENCE ON BUSINESS The social environment, which includes demographics and consumer preferences, represents the social tendencies to which a business is exposed. Some key social factors that have a significant influence on businesses are:  Attitudes and lifestyles  Socio-cultural Values and ethics  Demography – age, gender, ethnicity, population, etc.  Wealth distribution – income and social status  Health  Education  Law and Order  Religious believes Social factors Attitudes, values, ethics, and lifestyles influence what, how, where, and when people purchase products or services, are difficult to predict, define, and measure because they can be very subjective and qualitative in nature. These factors also keep changing as people move through different stages of life. People of all ages have a broader range of interests, defying a typical perception of a consumer. They also experience time in different ways and try to gain more control over their time. Changing societal roles have brought more women into the workforce as well as in schools, colleges and universities. This development is increasing disposable individual and family incomes, heightening demand for time-saving goods and services, changing shopping patterns, and impacting people’s ability to achieve a work – life balance. In addition, a renewed focus on ethical behavior within organizations across the hierarchy has managers and employees searching for the right approach when it comes to gender inequality, sexual harassment, and other socialconduct that impact the potential for business success. The demographics, or characteristics of the population, change over time. As the proportions of children, teenagers, middle-aged consumers, and senior citizens in a population change, so does the demand for a firm’s products. Thus, the demand for the products produced by a specific business may increase or decrease in response to a change in demographics. For example, an increase in the elderly population has led to an increased demand for many prescription drugs. Changes in consumer preferences over time can also affect the demand for the products produced. Tastes are highly influenced by technology. For example, the availability of pay-per-view television channels may cause some consumers to stop renting DVDs. The ability of consumers to download music may cause them to discontinue their purchases of CDs in retail stores. As technology develops, demand for some products increases, while demand for other products decreases. Many businesses closely monitor changes in consumer preferences so that they can accommodate the changing needs of consumers and increase their profitability as a result. Business organisations need to respond to changes in society, including demographic changes. If they do not, they will continue to offer products and services that are increasingly less relevant to the needs of customers. The marketing concept in business requires that all successful businesses must keep up to date with and aware of social and demographic change, and respond accordingly.  Example: Social, cultural and demographic factors Here are just a few examples of social and demographic changes;  Outing and dining out habits of a particular area or particular region.  Social media addiction has changed dynamics of societies. 20 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN CAF 6: MFA CHAPTER 3: SOCIAL AND LEGAL ENVIRONMENT OF BUSINESS  Domestic travelling and international travelling, especially in summer and winter vacations.  People interested and concerned with their looks, and attend social gatherings.  People concerned about health and weight. Interest in fitness, healthy eating and diets has increased.  The average age at which children leave their parental home has increased. Many children are staying on at home until they are 25 or 30 years old – a much higher number than in the past.  There has been an increase in the number of ‘single–parent families’  There has been a large number of people entering the country as migrants and a large number emigrating to live in other countries. Social factors in the environment refer to changes in habits, tastes, values and preferences. In the short-term social attitudes and habits are also affected by fashion. Cultural factors are the customs, traditions and behaviours of people in a given country it also includes fashion trends and market activities influencing actions and decisions. Demographic factors are concerned with a specific aspect of society – the size, spread and distribution of society. A. Attitudes and Lifestyle Consumer lifestyles and attitudes are continually changing. The constant shift of culture due to globalization and rapid advancements in technology impact consumer’s practices of buying certain products, responding to advertisements and venturing out to certain places. These preferences and values influence consumer lifestyles and in turn create implications for businesses. By gaining an in-depth knowledge about consumer preferences, as well as tracking changing patterns, businesses can create and benefit from opportunities. For example, with the younger generation being more aware of current trends through social media, a lot of parents now rely on their children while making purchases such as a new laptop or television. Also, when all the information is available on the internet with a click, the trend of reading newspapers is almost obsolete. Today in urban centers people buy products based on the ratings and reviews of previous consumers. This is a new trend and it is increasing day by day which affects businesses and their performance. i. Culture Globalization has also enabled companies to produce the same items for different regions as customers all over the world follow similar or popular trends. However, strong differences still remain among the choices that consumers make based on cultural beliefs. Businesses must relate to these differences, especially if they are entering a new region or country as a market. For example, there is more focus on family values and joint family units in Eastern countries, therefore multinational companies like Coca Cola and Pepsi use family gatherings and occasions as the backdrop of their advertisements in Pakistan and India. Like wise KFC, Pizza Hut, McDonalds and Sub Way franchises in Pakistan have multiple family deals to cater to the size and need of family gatherings and these deals are the most revenue generating for these MNCs. Also, a tea manufacturer would do better in UK rather than US as consumers in North Americas are predominantly coffee lovers. This is just a cultural preference among the two nations which would affect businesses of both tea and coffee. When initially launched, fast food chains such as McDonald’s did not perform well in China and Japan as the food served by them was not culturally popular. Later on McDonald’s had to introduce a wide variety of oriental flavours and variants to attract the pan Asian markets such as Japan and China. Likewise in Pakistan we have Tikka Pizza, Baluchi Pizza, Arabian Delight, Seekh Kebab Pizza which are not offered else where. THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 21 CHAPTER 3: SOCIAL AND LEGAL ENVIRONMENT OF BUSINESS CAF 6: MFA ii. Social and culture responsiveness It refers to people’s attitude to work and wealth; role of family, marriage, religion and education; ethical issues and social responsiveness of business. The social environment of a given region can have a significant impact on success. For instance, Food companies are highly impacted by this – certain cultures prefer certain types of foods. B. Values and Ethics Ethics is defined as the “discipline dealing with what is good and bad and with moral duty and obligation”. Business ethics is concerned with truth and justice and has a variety of aspects such as expectations of society, fair competition, advertising, public relations, social responsibilities, consumer autonomy, and corporate behaviour in the home country as well as abroad. Moral management strives to follow ethical principles and precepts, moral mangers strive for success, but never violate the parameters of ethical standards. They seek to succeed only within the ideas of fairness, and justice. Moral managers follow the law not only in letter but also in spirit. The moral management approach is likely to be in the best interests of the organization in the long run. They practice and portray the following values:  Honesty  Integrity  Trustworthiness  Loyalty  Fairness  Responsibility (Corporate Social Responsibility)  Obedience to elders  Respect of others  Righteous means of earning. C. Demography Demographic factors are uncontrollable factors in the business environment and extremely important in the business environment. Demography is the study of key statistics about the society or a certain segment of it such as their age, gender, race and ethnicity, and location. Demographics help the businesses define the markets for their products and services. It also determines the size and composition of the workforce. Demographics are at the heart of many business decisions. Businesses today must cater to the unique shopping preferences of different generations or age groups, each of which require different marketing approaches and products and services that are targeted to their needs. Today all the brands of all kinds of merchandise open their stores and sales points based on the demographic study of any city or area within a city. For example Saphire (clothing brand) would invest to open a store in Clifton but not in Surjani and this decision would be based on the buying power of the residents of the location. i. Age groups Such as the consumers born after 2000 are called the millennials. Since they have been exposed to so much change in the world as compared to their parents, they have a changed outlook about everything and therefore demand products and services that are more aligned to their mentality. Millennials now comprise of a large chunk of the population around the world and therefore hold a significance in every businesses’ marketing strategy. These are technologically savvy and prosperous 22 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN CAF 6: MFA CHAPTER 3: SOCIAL AND LEGAL ENVIRONMENT OF BUSINESS young people with comparatively larger disposable incomes to spend. They spend more freely and spoiled by more options around them that were available to their ancestors. Compared to their parents they have the tendency to spend all and save nothing lifestyle. Secondly unlike their parents they have a more individualistic approach towards life. Other consumers such as Generation X – People born between 1965 and 1980 – and the baby boomers – born even before – between 1946 and 64 – have their own spending patterns. Many boomers are nearing retirement and have money that they would prefer to spend on health and comfort or other leisure activities of their later years. In South Asian countries such as Pakistan, these people could also be a good target market for long-term investment prospects as they would like to leave their children in a financially stable position. As the population ages, businesses are offering more products that appeal to middle-aged and senior markets. ii. Ethnicity and nationality In addition, minorities represent more than 38 percent of the total population in the US, even greater numbers are present in Canada, Australia and the Middle East, with immigration bringing millions of new residents to different countries over the past several decades. By 2060 the U.S. Census Bureau projects the minority population to increase to 56 percent of the total U.S. population. Companies recognize the value of increasing diversity in their workforce as a reflection of the society and encourages the experience they bring with them that gives a broader view to a business’ overall strategy. For the economy, the buying power has of minorities has also increased significantly as they bring their life savings to a new country and spend to settle into a new life. Therefore, companies are developing products and marketing campaigns that target different ethnic groups. The discussion above is based on the target market and buying power of ethnic groups. The ethnic diversity is also very important for a prosperous and progressive businesses. We have seen that in USA multinational composition of global organization has added unimaginable value to the organisations. The foremost example is the appointment of Sunder Pichai as CEO of Google. This is also a great initiative to make 1.3 billion people believe in Google and associate with it as well. iii. Ageing population For some Western countries, especially countries of Western Europe, there is an ageing indigenous population. The birth rate is historically low, and the number of new babies per woman of child-bearing age has fallen. Traditional family system is not being appreciated and birth rate has fallen down which is a major cause for the lack of working age groups population. At the same time, average life expectancy has been increasing. More people are living until an older age than in the past. As a consequence, there is an ageing population, which means that a larger proportion of the population than in the past will be of an older age – say past normal retirement age. Governments are aware that the consequence of this demographic change is that in the future, there might be a relatively small working population and a relatively large number of people in retirement. The ‘few’ in work might be expected to support the ‘many’ in retirement, for example by paying taxation to fund state hospital services and many thousands of retired civil servants. iv. Government policy for demographic change A government might try to develop a policy for social and demographic change. For example, in a country with an ageing population, the government might consider the following measures.  Permitting immigration of people from other countries, possibly under a controlled immigration scheme, in order to increase the size of the population at working age. THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 23 CHAPTER 3: SOCIAL AND LEGAL ENVIRONMENT OF BUSINESS CAF 6: MFA  Increasing the average age at which individuals may retire with entitlement to a state pension.  Encouraging individuals to work beyond their normal retirement age.  Providing some form of subsidy or tax-incentive to individuals/couples who have children. Business organisations are affected by social and demographic change, and by government policy. As a population changes, in age or ethnic origin, the needs and wants of consumers will change. Businesses must respond to those changes. In addition, the nature of the workforce – its age distribution, availability and skills – will also change. Issues such as education and training take on importance for ageing employees as well as young employees, if companies intend to employ them beyond their normal retirement age. v. Migrated or immigrant population: In the modern world the international boundaries are fading away due to the constant and ever- increasing migration from one country to another due to several reasons. In Europe and other Western countries, it he recent past where there is a decreasing fertility rate however at the same time the number of migrant population is increasing and the fertility rate of the migrant population in Europe is much more than the locals. This is directly affecting the market and businesses in Western world. Where there used to be only Western choices now there is a large market for the Eastern goods and products which are consumed by the migrants and their second generation born there. D. Wealth distribution – income and social status Socio-economic issues affect consumer spending such as poverty and unemployment. These issues demand special attention from business on businesses as they have to develop policies/support systems/ informative programs to address them and also consider these factors while introducing products and services in the market. Businesses are also expected to create as many job opportunities as possible to contribute to the government’s role in addressing these issues. This could add to the financial burden on the business. Moreover, businesses have to define their target markets around different income groups. Such as luxury watch company like Rolex would not advertise in the classified ad sections of the newspaper. Similarly, Imtiaz Supermarkets targets middle-income to lower income segments by claiming to have lower prices and larger variety of brands under one roof. A promotional offer on grocery items from Imtiaz Supermarket would have to have mass reach so that all middle-income to lower income segments are targeted. E. Health and Education i. Health Health and well-being are important for businesses to prosper in a society. Healthy individuals can contribute to economic progress in a country. Social indicators such as life expectancy and birth/death rates direct businesses to formulate an appropriate strategy. Birth rates and life expectancy are important social indicators related to health that businesses use while doing business planning. For example, a higher birth rate would indicate a greater need for baby products such as formula milk and diapers. Life expectancy indicators could have vital implications for the health insurance companies as they market their insurance plans and health plans. Also a nation with a higher life expectancy is equipped with a larger labour force and has positive implications for businesses such as manufacturing and production industries. Moreover, for industries related to drugs, pharmaceuticals and medical equipment the health and well- being statistics are an important factor to devise business strategies. 24 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN CAF 6: MFA CHAPTER 3: SOCIAL AND LEGAL ENVIRONMENT OF BUSINESS For example, COVID-19 has changed the business scenario for the entire world. Where there have been positive growth opportunities for pharmaceutical companies and communication technology, industries such as travel and tourism have been affected adversely. Lastly during the Covid-19 business all over the world was affected heavily due to the lockdowns and some countries these lockdowns lasted several months. The businesses learnt how to work around the restrictions and to stay afloat and relevant to the market. For example we saw in Karachi that after few weeks of total lockdown the shopkeepers, retailers, wholesalers, mobile market, appliances sellers etc. all posted banners on their closed shops with their social media contacts for orders and home delivery. They all were forced to create social media contact with their potential buyers and proved a social media platform as alternate. ii. Education Businesses compete in a global economy that requires increasingly higher levels of education and training. Illiteracy among the population threatens the ability of businesses to compete on a global level. If a country falls behind other countries in education and training for its workforce in science, technology, math and engineering, it puts businesses at a disadvantage in competing globally with better educated workers. Moreover, companies also adapt their advertising and communication according to the literacy and awareness of their target market. Literacy and education also affects business expansion into other countries where there is a large business potential but setting up operations and transfer of technology becomes difficult if proper human resource is unavailable in the country or region. There is another side to the education and skill set. Traditionally the directly qualified professionals from educational and training institutions were regarded as hot cakes in the market and they were highly paid. This is the case today as well however a trend has also penetrated in the market, and it has garnered acceptability. According to many reports people with no college degree are also given jobs in many multi-national organisations based on their ability of problem solving and teamwork. Google is a leading example of such hirings. They give employment seekers with real world problems and gauge their ability to solve it and handle it. F. Law and Order Any unlawful and harmful act related to loss of goods in a business due to robbery, theft, corruption or hijacking impacts the business and the environment it operates in. A negative law and order situation in either a specific vicinity, city or entire country would affect the business negatively as well. The following are some negative effects of an unfavorable law and order situation;  Loss of staff and customers.  Insurance/security costs become expensive.  Loss of profits due to stolen goods from businesses.  Business lose skilled people resulting to a decline in productivity.  Businesses spend money on installing effective security measures e.g. alarms, burglar proofing.  Cost of damage to property increases as businesses pay higher insurance premiums to protect themselves.  Lower profits affect the decision to expand and employ more people/pay higher wages.  Crime causes increase in health costs of employees due to injuries or stress.  Discourages foreign investment and reduces tourism which impacts negatively on business During the period of political turmoil in Karachi many businesses were threatened by extortionists and they closed their units in Karachi and relocated them in other parts of Pakistan. THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 25 CHAPTER 3: SOCIAL AND LEGAL ENVIRONMENT OF BUSINESS CAF 6: MFA 2. LEGAL ENVIRONMENT AFFECTING BUSINESS A. The Role of Legislation in Business The legal system of a country is very important to businesses. A country’s law regulates business practices, defines business policies, rights and obligations involved in business transactions. For example, business laws may:  make a business or a transaction illegal  impose conditions on certain businesses  regulate the rights and duties of people carrying out business in order to ensure fairness  protect people dealing with business from harm caused by defective services  ensure the treatment of employees is fair and un-discriminatory  protect investors, creditors and consumers  regulate dealings between business and its suppliers  ensure a level playing field for competing business It is also important to know that the government can change the rules and regulations concerning businesses from time to time. Therefore, to be on the good side of the law, managers should ensure that they are up to date with laws. Here are some illustrative examples of how business can be affected by government policy and the law:  In 1970s private sector was nationalized in Pakistan, through Nationalization Act 1970.  In 2007, oil companies operating in the Orinoco region of Venezuela were required by the government to hand over majority ownership in their businesses to the state.  In 2007, a large shipment of corn to Europe from the United States was found to include genetically- modified corn. Although this was legal in the US, it was illegal in the European Union. The shipment had to be returned to the US. B. Different types of Laws affecting businesses i. Companies law In Pakistan, if a business set-up intends to form a public or private company, it is required to complete the requirements for incorporation, management, operations and winding up of companies, provided in the Companies Act, 2017 (the Act), issued by the Securities and Exchange Commission of Pakistan (SECP). The Act regulates companies for protecting interests of shareholders, creditors, other stakeholders and general public and inculcate principles of good governance. Companies are required to comply with the requirements of the Act, for which they will be required to incur certain cost, with respect to incorporation, human resources, audit of financial statements, holding of annual general meetings, record keeping etc. The companies which do non-compliance with the requirements of the Act will be subject to penalties imposed for the relevant offence. ii. Partnership law The law relating to partnership businesses in Pakistan is the Partnership Act, 1932. The Partnership Act includes the procedure of registration and dissolution of a firms, rights and duties of partners etc. In comparison to companies, partnership firms have ease of doing business as the requirements applicable on companies for annual filing of returns, audit of financial statements, holding of annual general meeting etc are not applicable on partnership firms. 26 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN CAF 6: MFA CHAPTER 3: SOCIAL AND LEGAL ENVIRONMENT OF BUSINESS iii. Employment law Each country has employment laws. The purpose of employment law is mainly to provide protection to employees, against unfair treatment or exploitation by employers. Business organisations, as employers, are directly affected by employment laws. They need to be aware of the employment law in each country in which they operate, and understand the consequences of breaking the law or failing to comply with regulations. Here are some of the aspects of employment law.  Minimum wage: A country might have a minimum wage, which is the minimum hourly rate of pay that may be paid to any employee.  Working conditions: A variety of laws and regulations might specify minimum acceptable working conditions, such as maximum hours of work per week or month. There might also be laws relating to a maximum retirement age and the employment of children. Working conditions are also covered by health and safety law.  Unfair dismissal: Employment law might give employees certain rights against unfair dismissal by an employer. An employee who is dismissed from work might bring a legal claim for unfair dismissal. The employer must then demonstrate that although the employee has been dismissed, the dismissal was not for a reason or under circumstances that the law would consider ‘unfair’. When an employer is found guilty of unfair dismissal, it might be required to reemploy the individual who has been dismissed or (more likely) pay him or her substantial compensation.  Redundancy: In some countries, dismissal of employees on the grounds of redundancy is not unfair dismissal, provided that discrimination is not shown in the selection of which individual employees should be made redundant. However, a country’s laws may require an employer to consider transferring an employee to another job before deciding that redundancy is unavoidable. (Failure to consider transferring employees to other work would mean that the dismissals for redundancy are unfair.)  Discrimination: Some countries have extensive laws against discrimination, including discrimination at work. For example, employers might be held legally liable for showing discrimination against various categories of employee (or customer) and also for discrimination shown by employees against colleagues. There are laws against discrimination on the grounds of physical disability, gender, race, religion, sexual orientation and age.  Gender Equality. Many countries including Pakistan have laws for anti-harassment to eliminate the gender biasness, women protection at workplace, gender sensitization and gender equality in the society. iv. Health and safety law Health and safety law provides rules and regulations about minimum health and safety requirements that employers must provide in their place of business and for their employees. Standards of health and safety law vary substantially between countries, although in countries with well-developed economies, health and safety standards are usually high. It is also important to recognise that health and safety regulations can impose significant requirements on employers, and the legal consequences of failure to comply with the regulations could be serious for the company or the directors, managers or employees responsible. In some countries, employers are required by law to provide a safe workplace for their employees. A safe workplace is one where employees are not exposed to unreasonable physical dangers or unreasonable risks to health. In some countries, this also means a place of work where employees are not subjected to discrimination or bullying. Risks to health and safety should be reviewed regularly, by means of formal risk assessments. THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 27 CHAPTER 3: SOCIAL AND LEGAL ENVIRONMENT OF BUSINESS CAF 6: MFA v. Data protection law Some countries have fairly strict data protection laws. The purpose of data protection law is to protect individuals with regard to personal data about them that is held and used by other persons. Data protection legislation is designed to protect the private individual against others collecting, holding and using information about them without their permission. It might be considered illegal, for example, that any organisation should be able to:  gather and hold personal data about individuals without a justifiable reason, and  make use of that personal data without the individual’s permission.  Someone holding and using personal data about individuals should also be under a legal obligation to:  make sure that the personal data is accurate, and  ensure the security of the data, so that it is not made available to or accessed by any other person who does not have any right to have it. vi. Cyber laws It is the newest area of legal system. It applies to internet and internet related transactions. This law was enforced to safeguard the individual’s information and confidentiality of clients where transactions are made over some network, collecting, storing, retrieving and disseminating of individual’s data. vii. Competition law Some countries have laws to encourage fair competition in markets and avoid anti-competitive practices. a) Monopolies There might be a law to prevent a company from acquiring monopoly control over a market. A ‘monopoly’ of a market is theoretically 100% control of a market, where only one entity supplies a product or service to the entire market. In practice, ‘monopoly’ is usually defined as a significant influence on the market. When a company has a monopoly of a market, it might engage in unfair business practices, such as charging higher prices than they would be able to charge in a more competitive market. The serious risk of anti-competitive behaviour from monopolies is the main reason for laws restricting them. When a company grows to the point where it becomes a monopoly, a government organisation might carry out an investigation, with a view to deciding whether measures should be taken to protect the public. Similarly, when two companies propose a merger that would create a new monopoly, a government organisation might investigate the proposed merger with a view to recommending whether it should be allowed to happen, and if so whether any conditions should be placed on the merger in order to protect the public. b) Anti-collusion regulations Collusion occurs when two or more business entities secretly agree to do something for their mutual benefit that is against the public interest. Typically, it is a secret agreement to raise prices, and avoid competition on process. In many countries, collusion is a criminal offence. c) Price controls In some countries, the government might impose price controls on certain key products or services, such as the price of essential services to consumers – water, electricity or gas. Official bodies might be established to monitor the activities of ‘utility companies’ (providers of water, sewage, electricity and gas services) and might have powers to restrict their activities. Official approval might also be required for any increase in prices. 28 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN CAF 6: MFA CHAPTER 3: SOCIAL AND LEGAL ENVIRONMENT OF BUSINESS viii. Consumer protection Most countries have legislation in place that aims to protect consumers of goods and services. These measures include contract law and sale of goods legislation. Sale of goods legislation Such legislation usually specifies that in contracts for the purchase of goods (or services) there are certain terms in the contract that a consumer may rely on. For example:  Title – The buyer is entitled to assume that the seller of goods actually owns them (i.e. has title to them).  Description of goods – The buyer is entitled to assume that any good they purchase correspond to a seller’s description of those goods. Quality – All goods supplied in the course of a business must be of satisfactory quality. This means that they must be satisfactory for the purpose intended. If a person buys a washing machine that does not work the seller must repair it, replace it or pay a refund to the customer. ix. Copyrights, Patents and Licenses Copyright and Patent laws are necessary to protect intellectual property of individuals and businesses. Copyrights safeguard “original creations” such as writings, art, architecture and music from being copied or reproduced. For as long as the copyright is in effect, the owner has the exclusive right to display, share, perform, or license the copyrighted work. A Patent is a registered right that gives the owner exclusive right to features and processes of inventions. A License is a permission to carry out certain business activities or practice under specific government regulation or certification body. THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 29 CHAPTER 3: SOCIAL AND LEGAL ENVIRONMENT OF BUSINESS CAF 6: MFA 3. LEGAL ENVIRONMENT AND EASE OF DOING BUSINESS Economic activity requires sensible legal system that encourages growth and avoid creating distortions in the marketplace. These laws include rules that establish and clarify property rights, minimize the cost of resolving disputes, increase the predictability of economic interactions and provide contractual partners with core protections against abuse. All these measures identify the prospects of success for business activity in relation to the legal environment. Moreover, a business would consider these measures to judge the level of risk involved in terms of time and money involved in setting up. Businesses get a strategic analysis to understand the dynamics of the business environment and strategize to achieve their objectives. A business manager examines many factors, such as the overall quality of an economy’s business environment, the financial system, market size, rule of law, and the quality of the labour force before investing. There are now generally accepted ease of business indices that gave a good insight into country’s regulatory environment. World Bank Ease of Doing Business Index Launched in the year 2003, the World Bank’s Ease of Doing Business Report (EoDB) ranking is an assessment of business regulations across 190 economies. Though the evaluation by the World Bank is not the only one published to indicate relative openness of the business environment in economies, the annual EoDB ranking is often cited as the most authentic indicator of the regulatory environment for business operations. A high ease of doing business ranking means that the regulatory environment in such country is more conducive to the starting and operating a local business. Ease of Doing Business Index comprises of ten Indicators on the basis of which ranking is issued;  Starting a Business  Getting credit  Construction permit  Getting electricity  Registering property  Protecting minority investors  Resolving insolvency  Enforcing contracts  Trading across borders  Paying taxes 30 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN  CHAPTER 4 INFORMATION AND COMMUNICATION TECHNOLOGIES IN THIS CHAPTER 1. The Impact o