Presentation - Session 08

7/27/2019 Presentation - Session 08

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Advanced FinancialConcepts and Accounting



© Copyright Coleago 2010

Learning Objectives

Principles Appreciate the fundamental principals of accounting

Fixed Assets Examine the accounting treatment for fixed assets –

depreciation and amortisation

Interest & Tax Deductions in the profit and loss account before the

net profit figure

Economies of Scale

Develop and understanding of economies of scale inthe telecom industry

Network Sharing Reducing fixed costs through network sharing

1




Learning Objectives





net profit figure

Economies of Scale



2



Fundamental principles of accounting

Historic Costs Transactions are recorded at the cost at which they take place

Matching or Accruals

Costs and revenues should be matched one with the other and dealt with in theaccounting period to which they relate

Going Concern

Assumes that a business will continue in operational existence for theforeseeable future

Prudence

Accountants take the most prudent view of revenues and costs

Consistency

Consistent treatment for similar items in a period and between periods

© Copyright Coleago 2010 3



T-Accounts, Trial Balances and Double Entry Bookkeeping

Cash Account

MobileSwitching

Centre

$1m

Debit Credit

Fixed Assets

Cash $1m

Debit Credit

Trial Balance

Fixed Assets

$1m Cash $1m

Debit Credit

Total

Debits

$1m Total

Credit

$1m

The Cash Account

If in doubt, start with cash.

However, the cash account is counter intuitive to normal personal banking. Adebit represents cash being received bythe company and a credit represents cashleaving the company.




Principals of double entry bookkeeping

For each transaction accountants make a debit and a credit entry

Entries are made in T-Accounts

The balances from all the T-Accounts provide a Trial Balance a list of all debitand credit entries

Each side of the Trial Balance must be equal

From the TB the financial statements can then be prepared



http://slidepdf.com/reader/full/presentation-session-08 7/34© Copyright Coleago 2010

Learning Objectives





net profit figure

Economies of Scale



6



Depreciation and Amortisation

Depreciation and Amortisation chargesrelate to the costs of “using” fixed

assets to support the generation of revenue

Revenue

Less Cost of Sales

Gross Profit

Less Operating Costs

Operating Profit (EBITDA)

Less Depreciation and Amortisation

Earnings Before Interest and Tax (EBIT)

Less interest

Earnings or Profit Before Tax (PBT)

Less Taxation

Profit After Tax (PAT)

Less Dividends

Retained Profits

Profit & Loss Account




Net Cash Flow from Operating Activities

Returns from investment and servicing of finance

Less Taxation paid

Less Capital Expenditure or “capex”

Less Dividends paid

Management of Liquid Resources

FinancingIncrease or decrease in cash over the period

Cash Flow Statement

Capital Expenditure, Fixed Assets and Depreciation

Revenue

Less Cost of Sales

Gross Profit





Less InterestEarnings or Profit Before Tax (PBT)

Less Taxation


Less Dividends

Retained Profits





Accounting for Fixed Assets - Depreciation

A fixed asset is an asset intended for use on a continuing basis in the business

To charge the cost of an expensive item of capital expenditure to the profit andloss all at once, when it is first purchased, would result in a massive lossfollowed by a period of high profits

When an assets provides a service to the business a charge for a proportion of

the asset should be matched against the revenues it helps to generate

This represents an application of the fundamental accounting principle of matching and involves spreading the cost of the asset over the period duringwhich it generates revenue

The cost of fixed assets are matched with revenues through an accounting

treatment called depreciation




Methods for spreading the costs of Fixed Assets

There are a number of methods of spreading the costs of fixed assets

The most common techniques are

– Straight line depreciation

– Reducing balance depreciation

This course concentrates on the first




Straight Line Depreciation

Straight line depreciation makes the same depreciation charge in each period

The charge per period is based up the expected Useful Economic Life (UEL) of the asset

The charge each period is calculated as follows

– Asset Purchase Price / UEL

This can be altered to take account of the expected sales proceeds for when theasset is no longer used

– (Asset Purchase Price – Sale Proceeds ) / UEL




Straight Line Example

Cost = 10,000, Sales Proceeds = 4,000 and UEL = 3

Depreciation Charge = (10,000 – 4,000) / 3 = 2,000

Year 0 1 2 3 4

Balance Sheet

Cost 10,000 10,000 10,000 10,000 0

Accumulated Depreciation 0 (2,000) (4,000) (6,000) 0

Net Book Value (NBV) 10,000 8,000 6,000 4,000 0

Profit and Loss Depreciation Charge

0 (2,000) (2,000) (2,000) 0




Intangible fixed assets

Cash can also be spent on non-physical assets which are used on an on-goingbasis within the business

Non-physical fixed assets are called intangible assets

– physical assets are called tangible

Examples of intangible fixed assets include

– Patents, content rights and 3G licences

The accounting for intangible fixed assets is identical to the accounting for tangible fixed assets

The term Depreciation is now replaced with Amortisation





Learning Objectives





net profit figure

Economies of Scale



14



Interest Income and Expense

Companies may have loans fromfinancial institutions and cash depositedat a bank

Interest charged on loans is debited tothe Profit and Loss account as an“Interest Expense”

Interest earned on cash deposits iscredited to the Profit and Loss accountas “Interest Income”

Revenue

Less Cost of Sales

Gross Profit





Less interest


Less Taxation


Less Dividends

Retained Profits





Corporation Tax

Companies are required to payCorporation Tax on its Profits

Corporation Tax is calculated on ProfitsBefore Tax (subject to certainadjustments)

The Corporation Tax rates vary fromcountry to country but usually fall in therange of from 25% to 40%

Corporation Tax is a debit entry in theProfit and Loss

The corresponding credit entry is thecreation of a creditor in the BalanceSheet until such time that the tax isactually paid

Revenue

Less Cost of Sales

Gross Profit





Less interest


Less Taxation


Less Dividends

Retained Profits





Profit After Tax, Dividends and Retained Profits

After Corporation Tax has beencharged the remaining profits are calledProfits After Tax

These represents the profits availableexclusively to the equity owners of thecompany as interest to the providers of

debt financing has already been paid

These can be paid out as a dividends or retained in the Balance Sheet asreserves, representing an increase inshareholder funds

Revenue

Less Cost of Sales

Gross Profit





Less interest


Less Taxation


Less Dividends

Retained Profits





Revenue to Free Cash Flow

Total Revenue

Gross Profit

Operating Profit or EBITDA

Free CashFlow

Cost of Sales

Cost of Sales

OperationalExpenditure

Cost of Sales

OperationalExpenditure

CapexCashTaxes

Free cash flow is notthe same as profit

Capital expendituredoes not hit the P&L





Learning Objectives





net profit figure

Economies of Scale



19



Cost types within a business - fixed and variable costs

Variable costs vary with volume, fixed costs do not (at least in the short term or for

small, incremental changes)

Customers, Calls, Revenue, Volume

$

Direct or Variable Costs

Customers, Calls, Revenue, Volume

$

Indirect or Fixed Costs


Telecom companies often have high levels of fixed costs relative to their



Telecom companies often have high levels of fixed costs relative to their variable costs

A company that has high operating costs (fixed)relative to its cost of sales (variable) is said to beoperationally gearedRevenue

Less Cost of Sales

Gross Profit





Less Interest


Less Taxation


Less Dividends

Retained Profits


Variable

34%

Fixed

66%

Fixed and Variable Costs in the Mobile Industry




Fixed costs and gearing

Depreciation and amortisation are fixed accounting

charges

Interest charges are also fixed and create financialgearing

Variable23%

FixedIncluding

D&A77%

Fixed and Variable In. D&A Costs in Mobile

Revenue

Less Cost of Sales

Gross Profit





Less Interest


Less Taxation


Less Dividends

Retained Profits





The cost structure of MVNOs compared to facilities based operators

VariableCosts34%

FixedCosts66%

Mobile Network Operator

VariableCosts70%

FixedCosts30%

MVNO

Mobile Network Operator

MVNO

The proportion of fixed and variablecosts in a mobile virtual networkoperation (MVNO), i.e. an operator without its own radio network, are almostthe exact inverse compared to a mobilenetwork operator.

The MVNO can operator at a much

lower scale, i.e. be profitable with fewer customers.




Gearing and economies of scale

A company that has high fixed costs and low variable costs (high gearing) willexperience a disproportionate change in profits for a given change in revenue compared

to a business which has a lower level of gearing – the effect of economies of scale

Total RevenueRevenue Growth

Cost of Sales (Variable)

Gross ProfitGross Profit Margin

Operating Costs (Fixed)

Operating ProfitOperating Profit MarginOperating Profit Growth

Network Operator

10,000 12,00020%

(2,000) (2,400)

8,000 9,60080% 80%

(6,000) (6,000)

2,000 3,60020% 30%

80%

MVNO

10,000 12,00020%

(6,000) (7,200)

4,000 4,80040% 40%

(2,000) (2,000)

2,000 2,80020% 23%

40%

Network Operator MVNO


The effects of economies of scale are vividly seen below – a reduction in



The effects of economies of scale are vividly seen below a reduction inrevenues would have an equally dramatic effect in reverse!

61.0%

36.4%

20.3%

6.8%

7.3%

0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0%

EBT

EBIT

EBITDA

GrossProfit

Revenue

Change 2002 to 2003

Orange UK Profit & Loss Account 2002 vs. 2003


St t i i li ti f hi h fi d t f t l t k t



Strategic implications of high fixed costs of telecoms network operators

Companies with high fixed costs must achieve a critical mass of customers to

generate sufficient contribution (gross profit) to at least cover their fixed costs.

Witness the initial “land grab” of customers during the growth phase of the

industry life cycle for mobile

New entrants with networks must spend to reach critical mass – often to thedetriment of the industry profit pool as a whole

Once critical mass has been achieved, companies continue to place an emphasison market share.

The battle for market share will continue in provided that incremental customersgenerate a positive contribution towards fixed costs.

However there is a risk that price competition will lead to the industry as a wholebecoming unprofitable.


St t i i li ti f hi h fi d t f t l t k t



Strategic implications of high fixed costs of telecoms network operators

High operational gearing increases the volatility of the returns of a company which

makes it more risky and so investors demand a higher return.

Corporate finance theory suggests that if you have high operational gearing youshould avoid high levels of financial gearing as this will compound the volatility of your returns.

Unfortunately many telecoms companies remain straddled with high levels of financial gearing.

In an uncertain market players will attempt to avoid increasing their fixed costs or look to reduce them in order to reduce operational gearing.

Restructuring, redundancy and off-shoring

Revenue sharing deals rather than upfront payments for content


L i Obj ti




Learning Objectives




Interest & Tax Deductions in the profit and loss account before thenet profit figure

Economies of Scale



28

The significant investment in transmission required for HSPA and LTE



g qnetworks push mobile operators towards network sharing

Network ABTS/Node B

Network BBTS/Node B

Network A

BSC/RNC

Network B

BSC/RNC

Network ABackhaul

Network BBackhaul

Shared MastShared Site

Antenna A

Antenna B

CoreNetwork A

CoreNetwork B

Site / Tower Sharing

Note: In somecases only the

tower is shared

RAN Sharing

SharedBTS/Node B

Shared

BSC/RNC

SharedBackhaul

Shared Antenna

CoreNetwork A

CoreNetwork B

Shared MastShared Site

RAN sharing goes well beyond site sharing. It implies sharing the entire AccessNetwork, including backhaul equipment. Traffic is split at the point where the MNO’s

core networks take over.


Core network sharing is as yet uncommon and beyond the sharing of the



g y y gbackbone it is likely to remain marginal

Core Transmission Ring Sharing

SharedTrans-mission

Ring

Netw.AMSC

Netw.AHLR

Netw.ASGSNGGSN

Netw.AOMC

Netw.BMSC

Netw.BHLR

Netw.BSGSNGGSN

Netw.BOMC

RANNetwork A

RANNetwork B

VASNetwork A

VASNetwork B

Shared Ring and Core Netw. Elements

SharedTrans-mission

Ring

Netw.AMSC

Netw.AHLR

Netw.ASGSNGGSN

SharedOMC

Netw.BMSC

Netw.BHLR

Netw.BSGSNGGSN

RANNetwork A

RANNetwork B

Shared VASPlatform

Requires technological and architectural commonality between sharing operators.The complexity is a main barrier for wide adoption


National roaming is a form of network sharing which does not involve



g gasset transfer

National Roaming

Network A

BTS/Node B

Network ABSC/RNC

Network ABackhaul

Mast A

Antenna A

CoreNetwork A

Subscriber of

network Broams onnetwork A

In some cases national roaming hasbeen used to help a new entrant whodoes not have lower band frequencies.

National roaming can also be a meansof two equal operators to share the costof rural coverage.


Network sharing can deliver cost savings in the network domain of up to 25%



Network sharing can deliver cost savings in the network domain of up to 25%

Potential cost Savings from Network Sharing

Sharing Model Savings in Roll-Out Capex Savings in Network

Operations and

Maintenance

Site / Mast Sharing

Civil works, some passive

RAN

Site rents

5-10% 5-10%

Transmission Sharing

Backhaul 5-15% 5-15%

RAN Sharing

Passive and active RAN

Site rents

Transmission capex / opex

20-25% 20-25%

Backbone sharing

Backbone (core network)

transmission

5-15% 5-15%

Core Network Sharing

Backbone sharing

Core network elements

15-25% 15-20%

Depends on the split of tower

vs. roof top sites with the

biggest capex saving po tential

fo r tower sites

Depends hugely on geography,

capacit ies required and

existing f ibre infrastructure

Joint f ibre backhaul

deployment f or mobile

broadband may deliver largesavings.




Session Summary

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Presentation - Session 08