Financial Reporting Basics (English version)

financial reporting The basics of ?

Aim of the presentation : in simple words with simple illustrations to introduce key concepts in financial reporting, used by telecom companies. Important disclaimer! All the definitions and all the illustrations have been very much simplified . They are meant to only give a basic general idea of the concepts, and cannot be used instead of proper textbook definitions .

Capital expenditure [ also known as c apex ] These are investments in purchasing equipment, property, licenses and other things needed for long term operation of the company. According to the financial accounting rules, capex are depreciated and amortized. Capex are usually very big sums

This is when the cost of an asset is “ spread over ” a number of years during which the asset will be used. Depreciation and Amortization

For example, in 2000 a telecom company bought network equipment costing in total 100 million dollars . The projected lifetime of this equipment – 10 years . 100 mil . / 10 years = 10 mil. dollars per year . During the next 10 years the company’s annual financial reports will include 10 mil. dollars as depreciation expenses for this equipment. Note ! Even if the entire sum of 100 mil. dollars for that equipment was paid in 2000, the financial reports would still have 10 mil. dollars as depreciation expenses each of the next 10 years. Depreciation and Amortization

million dollars 0 100 10 actually paid depreciation expenses, specified in financial reports 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 In other words, in reality : in 2000 – paid 100 mil . for the equipment in 2001 – paid zero for the equipment in 2002 – paid zero for the equipment … in 2009 – paid zero for the equipment But according to the rules of financial reporting: 2000 – Depreciation expenses 10 mil . ( when the sum actually paid was 100 mil . ) 2001 – Depreciation expenses 10 mil. (when the sum actually paid was 0 ) 2002 – Depreciation expenses 10 mil. (when the sum actually paid was 0 ) … 2009 – Depreciation expenses 10 mil . (when the sum actually paid was 0 ) Depreciation and Amortization

These are regular expenses by the company supporting its operational activity, e.g. salaries, rent, advertising etc. Operational expenditure [ also known as opex ] For example, in January 2001 the company spent 1 mil . dollars in salaries, 500 thousand in rent payments and 500 thousand for advertising. So the company’s total opex are 1 mil . dollars. Opex are not depreciated, i.e. they are not “spread over” a number of years, but are reported in full in the period when they were actually incurred.

Revenue This is all the money earned in a certain period of time.

EBITDA = revenue – opex Operational profit ( EBITDA ) [ Earnings Before Interest, Taxes, Depreciation and Amortization ] From all the money actually earned in a certain period we deduct all the operational expenses actually incurred in this period, and what remains is the operational profit ( EBITDA ) . Important indicator

Net profit = EBITDA – interest on loans – income tax – d epreciation and a mortization Net profit

EBITDA is a popular indicator in telecommunications, as well as in other industries which require considerable capital investments (capex) in setting up and rolling out the business. As capex in telecom are usually very big (because the equipment is expensive), and they are depreciated (i.e. “spread over” several years), the depreciation and amortization figures can seriously influence the net profit figure. Why we need EBITDA see example on the next page ...

For example, in 2001 the company earned 10 mil . dollars revenue . The operational expenditure ( Opex ) in that year was in total 2 mil . dollars. Therefore the operational profit ( EBITDA ) was 10 mil. – 2 mil. = 8 mil . dollars Depreciation and amortization expenses = 10 mil. dollars These expenses in 2001 exist only on paper. In reality these 10 mil. were paid in 2000, as part of the overall 100 mil. dollars payment for equipment in that year. After that those 100 mil. were “spread over” the next 10 years as “virtual” expenses, 10 mil. per year. Net profit = 8 mil . – 10 mil. = - 2 mil . In a financial report we have negative net profit, i.e. we have losses … However, in this particular example the reason for losses is the depreciation and amortization figures. (For the sake of simplicity, we don’t consider here the income tax and interest payments ). EBITDA removes from the picture the potentially distorting factors like depreciation. why we need EBITDA In other words , EBITDA shows the company’s ability to earn money.

EBITDA margin EBITDA margin = (%) EBITDA margin shows what per cent of revenue is operational profit . In our example it is 8 mil . / 10 mil. = 0.8 , that is 80 %

We invest c apex , which are then depreciated and amortized . Work hard, earn r evenue . From r evenue in a certain period we deduct opex in that period, the result is EBITDA in that period . A positive EBITDA means that the business has reached operational profitability. EBITDA in that period is divided by revenue in that period, the result is multiplied by 100 (to get a figure in per cent) – this gives EBITDA margin in that period . From EBITDA we deduct interest payments, income tax, depreciation and amortization expenses, the result is net profit in that period . A positive net profit means that the business has passed break-even point and is profitable . Mobile operators reach break-even on average in 7-8 years. Although in reality a lot depends on the peculiarities of the specific market where the company operates. Bringing it all together

Financial Reporting Basics (English version)

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Financial Reporting Basics (English version)