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Advanced FinancialConcepts and Accounting
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© 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
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© 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
2
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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
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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.
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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
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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
6
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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
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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 Operating Costs
Operating Profit (EBITDA)
Less Depreciation and Amortisation
Earnings Before Interest and Tax (EBIT)
Less InterestEarnings or Profit Before Tax (PBT)
Less Taxation
Profit After Tax (PAT)
Less Dividends
Retained Profits
Profit & Loss Account
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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
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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
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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
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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
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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
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© 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
14
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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 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
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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 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
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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 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
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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
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© 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
19
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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
© Copyright Coleago 2010 20
Telecom companies often have high levels of fixed costs relative to their
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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 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
Variable
34%
Fixed
66%
Fixed and Variable Costs in the Mobile Industry
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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 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
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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.
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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
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The effects of economies of scale are vividly seen below – a reduction in
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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
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St t i i li ti f hi h fi d t f t l t k t
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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.
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St t i i li ti f hi h fi d t f t l t k t
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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
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L i Obj ti
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© 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 thenet profit figure
Economies of Scale
Develop and understanding of economies of scale inthe telecom industry
Network Sharing Reducing fixed costs through network sharing
28
The significant investment in transmission required for HSPA and LTE
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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.
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Core network sharing is as yet uncommon and beyond the sharing of the
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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
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National roaming is a form of network sharing which does not involve
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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.
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Network sharing can deliver cost savings in the network domain of up to 25%
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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.
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Session Summary