Financial Management Processes - Essay Example

I. TABLE OF CONTENTS A. Background Information The UAE Telecommunications Industry 2. The Company: Emirates Telecommunications Corporation (Etisalat) a. History b. Services Offered c. Organizational Structure d. Strategic management and strategic objectives 1) Vision and mission e. Corporate Performance f. The International Business Department 1) The Researchers roles and responsibilities B. Financial Management at Etisalat 1. Strategic and Operational Roles of Financial Management 2. Financial Policies and Practices a. Meeting stockholder expectations b. The contributory role of other departments c. Use of information technology in financial management C. Etisalat Financial Analysis 1. Purposes of Financial Statements 2. Income Statement Analysis 3. Balance Sheet Analysis 4. Cash Flow Statement Analysis 5. Ratio Analysis D. Financial Planning and Budgeting 1. The Concept and Role of Financial Planning 2. The Budgeting Process a. Budget preparation b. Budget approach and style 3. The Master Budget E. Budget Analysis and Forecasting 1. Variance Analysis 2. Budget Forecast for 2009 using Worst Case and Best Case Scenarios F. Capital budgeting 1. Investment appraisal 2. Investing AED1 billion in a project: An example a. Measures used in the appraisal 1) Payback period (PP) 2) Accounting rate of return (ARR) 3. Discounted cash flow a) Net present value (NPV) b) Internal rate of return (IRR) G. Report to Management (Appendix H) II. ACKNOWLEDGEMENTS III. EXECUTIVE SUMMARY This study of the financial management processes and related topics with a specific focus on Emirates Telecommunications Corporation (Etisalat) was conducted in order to better understand the role of financial planning, management, and analysis in achieving the strategic and operational objectives of the company. In particular, the researcher considered the concepts of financial planning and budgeting, performed vertical and horizontal analysis of the financial statements as well as computed the financial ratios that could help management, investors and creditors in understanding the operational viability and health of the organization. The researcher also applied budgeting concepts to financial data leading to the formulation of a master budget, and capital budgeting concepts to projects wherein it was necessary to estimate alternative returns on investment so that the correct investment decision could be made. Owing to fact that the UAE telecommunications industry is a duopoly with Etisalat controlling a major share of the domestic market, the superior financial performance was found to be stable and consistent with the companys projections. Strategic and operational decisions as reflected in the companys financial performance shows both prudence and aggressiveness, resulting in stable but improving results. Because the company is also in the forefront of information technology it can only become stronger as competition both domestically and internationally continues its course in line with the global trend of trade liberalization. The managements decision to continue expanding in other parts of the world, particularly in Africa and Asia, proves that the company has adopted a progressive and proactive approach considering the near-saturation of the UAE market for telecommunications services. This bodes well for the companys long-term financial success. The last section of the study dealt with capital budgeting, or the use of appropriate measures to determine whether projects being considered for investment are worthwhile from the companys point of view. For this purpose, the researcher applied standard measures, particularly the discounted cash flow method, in deriving the Net Present Value and the Internal Rate of Return. A memo to the management based on the findings of study constituted the last section of the study. IV. RESEARCH METHODOLOGY To conduct this study, the researcher used two basic methods. First, secondary research was used to derive theoretical background about the financial condition of the company through its financial statements and other sources. The tools used were: books, articles, and pertinent websites, and the companys latest Annual Report Secondly, the researcher used primary research consisting of interviews with the companys line managers and the Chief Financial Officer (CFO) to obtain essential information. V. THE STUDY 1. The UAE Telecommunications Industry The UAE telecommunications market is a duopoly dominated by Etisalat and du. Etisalat, which is also aggressively expanding its business internationally, has a larger market share; for example, it has 80 per cent in the mobile market while du accounts for the remaining 20 per cent.(Market Research) The UAE’s telecommunication market has grown tremendously in recent years, in the midstt of government policy to deregulate the market and stimulate competition. The Telecommunication Regulatory Authority is at the agency tasked to intensify competition in the UAE telecommunications market. This effort is consistent with the countrys commitment as a member, since 1996, of the World Trade Organization (WTO) by which the liberalization of the telecommunications industry is to be carried out fully by 2015. The national market consists of fixed-line, mobile subscribers, Internet subscribers, broadband subscribers and 3G subscribers. According to research data, the UAE mobile markets penetration in 2008 had reached 190 per cent, which may indicate that the market is fully saturated. Because of rapid growth, the average revenue per user in UAEs mobile sector, for example, continues to decline. Despite this, however, the market is forecast to grow by an annually compounded average rate of 7 per cent during the period 2009-2012. New revenues are expected to be derived more from value added services than from traditional sources. Because of the increasing number of Internet subscribers it is expected that broadband subscriptions are going to take more of the market share in the country than dial-up services. (Market Research Reports). 2. The Company: Emirates Telecommunications Corporation (Etisalat) Emirates Telecommunications Corporations provides telecommunications services in the United Arab Emirates and abroad. The telecommunications giant provides media and related equipment as well as related contracting and consultancy services to international telecommunications companies. The business divisions of the conglomerate are: Etisalat University College, UAEnic, e-vision, Ebtikar, the Contact Centre, Emirates Data Clearing House (EDCH), e-Academy and UAELAB. It offers fixed-line services over its Next Generation Network and equips mobile users with a wide range of services and applications, namnely, GPRS, 3G, BlackBerry and MobileCam. In 2007 the Group acquired Etisalat Software Solutions (India), Etisalat International Atlantique (Dubai), and Etisalat International Zantel (Dubai). Etisalat is the sixth largest company in the Middle East in terms of capitalization and revenue. a. History Before the entry of the sole competitor (du), Emirates Telecommunications Corporation (ETC) had been the sole provider of telecommunications services within the UAE in the since 1976. It has experienced tremendous growth in both scope of operations and financial performance. 1The current mobile subscribers have crossed the 7 million mark during the year 2008. The total calls, both national and international have also increased significantly over the years. b. Services provided The range of services provided by the company are summarized in the following table: SERVICES DESCRIPTION Voice Value added services - international toll free Direct exchange line – clip services Wireless GSM supplementary services Internet Email Learning online Data Fax Telex, Ethernet, ISDN c. Strategic management and strategic objectives While Etisalat continues to reap the benefits of its solid performance and services in the local market, recently it has been exploring the international markets for various attractive investments opportunities. It now has subsidiaries in Afghanistan, India, Egypt, Pakistan, and Sudan. In 2007 it entered into two new markets -- namely, Nigeria and Indonesia. With the large populations and relatively low penetration in these countries, these markets match Etisalat’s core corporate strategy perfectly and its mission of "extending people’s reach." Overall, the company strives to develop new technologies, products and markets. It seeks to create value for its customers and leverage on the latest technologies and add more on services (other than call charges) to enhance the revenue base. a) Vision and mission The companys vision as articulated in its 2008 Annual Report, is as follows: "A world where people’s reach is not limited by matter or distance. People will effortlessly move around the world, staying in touch with family, making new friends as they go, as well as developing new interests. Businesses of all sizes, no longer limited by distance, will be able to reach new markets. Innovative technologies will open up fresh opportunities across the globe, allowing the supply of new goods and services to everyone who wants them."(2008 Annual Report) The companys mission is to "extend people’s reach." To achieve this, the company is "developing advanced networks that will enable people to develop, to learn, and to grow. d. The International Business Relations (IBR) Department The International Business Relations (IBR) Department, where this researcher works, was established in 1996 as an independent department in response to the rapid changes and the expanding trend in the telecommunication industry in the global market. The department also handles international investments. In this area it conducts the study and review of potential investment opportunities and generates study documents and reports, carries out negotiations and other related work pursuant to a project, ensuring that the capital funds of the corporation are put to profitable use. The Departments organizational chart is as follows: International Business Organization Chart Although the IBR handles transactions of a financial nature, it does not deal with cash and only draws funds for various projects from the corporations central resources through appropriate management approvals and authorizations. Being an investment centre, it reports on its profitability based on the activities it handles.(Etisalat website) 1) The Researchers Roles & Responsibilities in IBR The researcher has been designated as Traffic Accounts Assistant. This is a temporary on-site job training where her task is to receive the financial data from the off-site locations of Etisalat through telephone, fax, PSDN and the Internet. She reviews the data and ensures that the credits are received at the correct or agreed rate. In case of disagreements, she submits queries and settles the matter in the best interest of the department and the company. This also involves the reconciliation of accounts payable and receivables. B. Financial Management at Etisalat Financial management is the acquisition, management and financing of resources for company by means of money. The fundamental determinants of the value of the company are the magnitude of future cash flows, their timing, and their riskiness( source ). Because of investor perceptions of changes in these variables, it is necessary to provide them with financial information through financial statements, reports, and other forms of communication. 1. Strategic and Operational Role of Financial Management Process The board of directors and top management determine the corporate and business strategy that the company adopts for the long term. This requires a long-term perspective of 5 years or longer. The strategic plan is broad in nature and scope, stating the general assumptions about the companys societal environment and task environments the government, labor unions, the community, interest groups), as well as the assessment of the corporate internal resources and capabilities, and weaknesses. All the members of the top management (finance, manufacturing, marketing, R&D, etc.) are to be involved by contributing their ideas in the strategy formulation process. The financial manager is a key participant because the implementation of the strategy involves costs, and his expertise and unique perspective would ensure that no future activities will be undertaken without taking into account the availability and commitment of the companys financial resources. 2. Financial Policies and Practices Financial policies are formulated at the highest levels of management, with the financial manager providing the major input that have impact on the financial side of the business. The financial manager must be aware of the companys broad strategic and operational goals so that these can be appropriately translated into the financial plan and budgets. Policies, which normally encompass a broad area, can cover such aspects as sources and uses of funds, assets to acquire and dispose of, the capital structure (the mix of long-term debt and equity), dividend decisions, among others. a. Meeting Stockholder Expectations It is important for all key officers of the company to understand that the ultimate goal of the enterprise is to increase shareholder wealth. Although there are some who argue that other stakeholders, such as consumers, credits, workers, and the local community, are also important, the stockholders interests are primordial because the investors are the providers of capital without which the business would not exist. Stockholders have their own expectations about dividends and the increase in the value of their holdings, otherwise they would unload their shares and cause the market value of the companys stock to fall. b The contributory role of other departments All departments have to coordinate with the financial manager because every activity that they undertake have financial implications. The manufacturing department have to purchase raw materials. The marketing manager needs to ensure that sales are in cash or receivables are converted to cash within a reasonable period of time. The sales force also needs their pay and incentives in order to perform a good job. The R&D department needs capital to carry out applied research which will have considerable impact on the companys long-term future. Any cash shortfall can have repercussions on the companys ability to meet obligations when they fall due. Because all aspects of operations have financial impacts, the financial manager must have some say on the activities of the other departments. c.The Role of Information Technology in Financial Management In the modern age when competition among firms has become more intense, it is the company which has tapped into the available information technology that has an edge. Information processing at the operational level makes information quickly availability for transmission to the various decision-making centers of the organization, especially the top management.. For the financial manager, specifically, the production of prompt and accurate data generated by modern information technology infrastructure and resources at the companys disposal makes it easy for the financial manager, and for the other executives as well, to react quickly to threats and take advantage of opportunities in the environment in order the improve the companys competitiveness. Fortunately, Etisalat is at the forefront of the movement towards the widespread use of information and communications technology. C. ETISALAT FINANCIAL ANALYSIS 1. Purposes of Financial Statements The Balance Sheet shows assets, liabilities, and stockholders equity at a point in time. The Income Statement reports the results of operations over a certain period. The cash flow statement for the investor shows the sources and uses of funds during the course of business. For management, these financial statements are helpful for anticipating and planning for the the future. Financial analysis enables one to diagnose trends that are indicative of the magnitude, timing, or riskiness of the firm’s future cash flows. 2. Income Statement Analysis The income statement shows a company’s sales, the cost of goods sold, expenses, and profit (or loss). Appendix A shows Etisalats Income Statement for 2008 and 2007. A common-size statement, as part of vertical analysis, was derived and included in the table, along with the percentage changes of the amounts corresponding to various items between the two periods. Summary During the year 2008 total revenue of the corporation increased by 23%. This clearly reflects the strong profit generating abilities of the corporation and is in line with the continued upward trend in the profit figures. Net profits for the year also increased by 11% and EPS rose from AED 0.94 in year 2007 to AED 1.17 in 2008. Balance Sheet: Its Purpose The balance sheet tells management and the companys investors about the assets that are employed by the management and its employees in order to achieve its goals. It also tells them what the sources of these assets are, whether they emanate from contributed equity or debt, or a combination thereof. The balance sheet indicates whether the assets have been used wisely or whether funds to finance operations were obtained at their most economical cost. In financial analysis, however, it is the relationship between the balance sheet and the income statement and with the cash flow statement that provides one a good assessment of the companys health and profitability. Appendix B displays the Balance Sheets of the company for the periods ending 2008 and 2007. Also computed and shown in the table are the common-size statements of the balance sheet items and the corresponding changes in their amounts between the two periods. 3. BALANCE SHEET ANALYSIS A brief description of the categories of balance sheet items is given below: A. Non-current Assets The non–current assets are comprised of fixed assets, investments in associate companies, other investments and loans to associate companies. The fixed assets have reduced by AED 123 million due to disposal of plant and equipment. The investments have increased due to investment in Sudan & other African countries for expansion purposes. B. Current Assets There has been increase in almost all the components of current assets but the biggest changes have been seen in Debtors and bank balances. Debtors and prepayments have increased by 81% mainly due to the investment activity of the Corporation wherein loans and advances have been made to various associated undertakings. Bank and cash balances have increased by 24% contributed solely by the AED 5 billion cash flows arising from operating activity. C. Equity During the Year 2008, 330 million bonus shares, each worth AED 1, were issued by the Corporation. The company, in line with its prudent and conservative funding policies has been appropriating AED 500 million annually for its Development reserve and Asset replacement reserves account. There is a huge increase in unappropriated profits of 116%. D. Current liabilities The overall current liabilities increase of 18% is normal and reflects the business trend prevailing in the market. The overall total asset base has increased tremendously and although a major contributor has been the increase in the current assets, an analysis of the current assets reveals that they represent current debts and not non-moving and old debts. Recovery of the debts is certain since most of the investments made are in Etisalat-owned projects. The Cash Flow Statement 4. CASH FLOW STATEMENT (CFS) Cash flows are used in financial management because they are essential to the financial well-being of the Company. The presentation in Appendix C shows the division of the statement into Operating (net income, assets, liabilities), Investment ( sales and fixed assets), and Financing (investors, short and long term debt). Cash flows are helpful because it indicates the sources and uses of cash for operational and related purposes. Summary of Cash Flows The Cash flow from operating activities continues to show positive results, recording a healthy increase of 16%. The cash flows from investing and financing activities were negative mainly due to the fact that Etisalat is currently in the early stage of expanding international investments and it will take some time before the existing investments pay off. 5. RATIO ANALYSIS Ratio For 2008 Remarks Current Ratio (Current Assets / Current Liabilities) 1.64 : 1 Fair Quick Ratio (Current Assets – Inventories) / Current Liabilities 1.63 : 1 Ratio is good because of low inventory level. Asset Turnover (Total Revenue/Assets) 0.58 times Net profit margin (Net Profit / Sales) x 100 33% The Corporation maintain Net Profit margin of 33% the previous year. ROI (Net income/total average assets ) 19.30% Previous year was 16.8% ROE (Net income/ average owners equity) 29.60% Previous year was 25.7% Dividend payout 42.30% Previous year was 48.0% Debt ratio (total liabilities/ total liabilities and equity 0.33:1 0.34:1 the previous year. SUMMARY OF ETISALAT FINANCIAL SITUATION 2Financial Position The cash and bank reserves of the company have increased from AED 7,801,763 to AED 9,658,510. The company does not have any long term debts but has shown an increase in its Creditors. Although the Liquidity ratio shows a comfortable coverage of 1.63, further analysis of the ageing of the creditors can be done to check if the debts are new or old. Overall the financial position of the company is strong and ideal for making investments. Financial Performance The increase in revenue of 23% for the Year 2008 reflects a healthy growth in the overall business of this organization. The profits for the year have also increased from AED 3.4 million to AED 4.3 million which once again confirms the strong profit generation capacity of the organization. The revenue share in each segment like mobile services, landline, and Internet services etc. have also increased. The growth of the company can also be assessed from the fact the numbers of users and the minutes of local as well as international dial ups have increased many times over. The net profits have risen by 25% and the Return on Investments (ROI) has also gone up by 28%. Sources of Cash flow The cash flow of the organization clearly indicates that it has a healthy source of operating activities that are generating cash to support both the investing and the financing activities, although it is projected in the future the investments made by the corporation will have a positive impact on the cash flows. The overall capital expenditure has gone down from AED 1.36 billion in 2007 to AED 1.26 billion in 2008. This may be due to the fact the company wishes to operate within the budgets and is keen to finish the on going projects as first priority. Apparently, the company shows prudence by limiting its risks D. Financial Planning and Budgeting 1. The Concept and Role of Financial Planning in the Company A financial plan is an instrument that consolidates plans of various parts of the corporation and quantifies them to ascertain whether they meet the organizations overall financial goals (Keat 2003). But financial plans are not created independently. It must be the result of an overall planning process involving the whole management. Certain steps have to followed: First, the objectives must be established by management, then the economic and competitive environment must be considered, as well as the opportunities and risks. The resources and resource constraints must be matched against the environmental factors, so that strategies can be developed to achieve the objectives. The objectives are transmitted to the various parts of the organization and translated into quantitative and qualitative targets. These areas will include targeted growth in revenue and profits, required resources and capital expenditures, technological advances, and new or improved products. The financial plan is the quantification of all these elements, and if the top management approves it, it becomes the basis of company operations. Because the internal and external environment can change, some changes and amendments will be necessary as the plan is being implemented. Financial planning, together with forecasting, is essential to the success of a company as it provides a road map to guide management towards achieving its objectives. The strategic financial plan has an outlook of from 5 to 10 years, while the operating plan has a 1 to 2 year outlook. 2. The Budgeting Process A budget is a planning and controlling tool that reflects the firm’s expected sales or revenues, operating expenses, and cash receipts and outlays. It quantifies the firm’s plans for a specified future period. Since it reflects management estimates of expected sales, cash inflows and outflows, and costs, the budget serves as a financial blueprint and can be thought of as s short-term financial plan. It becomes the standard for comparison against actual performance. a. Budget Preparation The preparation of the budget starts with the consideration of actual performance for the current period. The revenues and/or costs are determined and are then adjusted for the changes that are expected to occur in the future based on the objectives and targets set as well as on the changes in the environment. b. The Budget Approach and style With regard to the manner of preparing the budget, management may either use the top-down budgeting approach or the participative approach. In the first case, it is top management that dictates the budget and its components; while in the second case, lower-level management levels, which have a direct hand in implementing budgeted activities, play an important role. There are several types and uses of budgets. Harvard University has identified six budget types and their typical uses for each. The budget types are operating budget, corporation budget, sponsored budget, target budget, preparation budget, and forecast budget. It is believed that most organizations can do well with less. 3. The Master Budget In a large organization like Etisalat where the number of departmental budgets are eventually drawn together to form the overall master budget, there is a need to develop a system which links these together, depending upon the size of the organization and it organizational / administrative management structure. Etisalat follows an annual budgeting policy wherein every year the Head Office Finance Department sends requests for estimates from the various regions and departments for the revenue expected to be generated and expenses to be incurred. Consolidation with the overall corporate plans is then done a the head office level to formulate the Master Budget comprising of the Budgeted Balance sheet, Budgeted Profit and Loss Account, Budgeted Cash Flows etc. E Budget Analysis and Forecasting The actual and budgeted Balance Sheets are shown on Appendix D. The actual and budgeted income statements are presented on Appendix E. 1. Variance Analysis: a. The Balance Sheet As per Balance sheet comparison, the company has generally performed better than budgeted. We often look at the ADVERSE variables only and try to find out the root cause of the same so that the corrective actions might be taken before it becomes a serious problem. Only it has lacked in Fixed Assets, Stores and amount due from other telecom companies. Now, the reduction in Fixed Assets is due to the more of the external factors rather than the internal factors. The company seems to be risk averse and do not wish to take unnecessary risk in want of some exceptional market share or profits. It seems that in order to retain that policy, the company has restricted itself from investing hugely in the fixed assets and make any new capital expenditure. The other two variables namely, stores and amount due to other telecom administrators is normal and beyond company’s control. Rest every other item of the balance sheet seems to be OK. b. Income Statement Now we come to the Income Statement where other incomes have fallen short of the expectations. Other incomes constitute of contract revenue and the interest income. Rest of the Income Statement look good when compared with the budgeted one. 2. Budget Forecast for 2009 -Worst Case and Best Case Scenarios As a kind of sensitivity analysis designed to explore the impact of favorable and unfavorable events of the companys financial condition, budgets under the best case and the worst case scenarios have been prepared . The tables and options chosen for the both cases are shown in Appendix F The results On the basis of the analysis done for the worst case and the best case scenarios, the company has continued to show strong fundamentals, and it is believed that the company will remain profitable even in the the worst case scenario. This kind of study is important in the cases where strategies are to be made in respect of an unpredictable business environment. It gives the organization a leeway to operate with some degree of confidence that adverse developments can be overcome. F. Capital Budgeting Capital budgeting is the investment decision making process which consists of identifying the need for capital investments, analyzing courses of action to meet that need, preparing reports for management, choosing the best alternative, and dividing funds among competing resource needs (Needles et al 1999). 3. Investment appraisal A screening method to eliminate unprofitable or inferior projects is the minimum desired rate of return for each individual project being considered. The most common measures are: cost of capital, corporate return on investment, industrys average return on investment, and bank/federal interest rate (Needles et al 1999). In the study that follows the approximate rate of return on projects based on the weighted average cost of capital is estimated to be 12 per cent, hence this discount rate will be used. 4. Investing AED1 billion in a project: An Example On the basis of the budgets prepared above, the company plans to invest a total of AED 1 billion in the capital projects in the Middle East and African Countries. The basic assumptions and data for that project are as shown in Appendix G. Results: The table in Appendix 7 shows that, using a 12 percent discount rate, the Net Present Value would be AED913 million, which indicates that the true discount rate or Internal Rate of Return (IRR) would be much higher. Using trial and error, the researcher found that the true rate of return would lie somewhere between 35 percent and 40 percent as shown in the table. The present value of cash inflows would be 1117 for 40 percent and 1234 for 35 percent. Interpolation shows that the Internal Rate of return is 36.45 percent. a. Measures used in the appraisal 1) Payback period (PP). The payback period for the project is 2.42 years, or 2 years and 5 months, using the cumulative amounts in the series, and interpolated, so that the true recovery of investment, in present value terms, would occur at this point in time. 2) Accounting rate of return (ARR). The accounting rate of return is obtained by adding all the actual net cash inflow (not adjusted to their present values) and dividing the total by 5 years. Since the total was 2988, the average return was 598. This figure divided by the investment gives us 49.8 percent. The accounting rate of return is a rough measure and therefore not very reliable. 3. Discounted Cash Flow (DCF) The discounted cash flow is a valuation method used to estimate the attractiveness of an investment opportunity. It uses projected  free cash flows and discounts them to arrive at the sum of present values. d. The DCF formula is: a) Net present value. If the value arrived at through DCF analysis  higher than the current cost of the investment, the opportunity may be a good one.   The above analysis shows that projects Net Present Value (NPV) is positive - i.e., the IRR is greater than the cost of capital, and the project should be approve if it has the highest NPV among a group of alternatives. The formula for the Net Present Value: b) Internal Rate of Return (IRR) The Internal Rate of Return (IRR) is defined as the rate of return of a project using the DCF method. To arrive at the IRR, one must do two or more calculations to discover the rate that makes the current or present value of investment equal to the present value of all cash inflows from the project. Appendix 7 shows the application of the IRR and the computations done. G. Report to Management (Appendix H) VI. BIBLIOGRAPHY Brealey, RA, Myers, SC & Marcus AJ 1999, Fundamentals of corporate finance, 2nd edn., McGraw Hill, New York. Brigham EF & Gapenski, LC 1996, Intermediate financial management, 5th edn., The Dryden Press, Orlando, FL Cambridge University, Financial Management Module, Cambridge Executive Diploma Etisalat’ The Miracle Sector in UAE H.E. Ahmed Al Tayer – Ministry of Communications. Etisalat Annual Report Etisalat Annual Report 2008, viewed 5 November 2009 at http://etisalat.ae/assets/docs/financial/2007Flash/Flash2008/pdfs/english/etisalat_en08.pdf Etisalat website, viewed 5 November 2009 at http://etisalat.ae/index.jsp?lang=en&type=channel¤tid=bd48e15c0b56a010VgnVCM1000000a0a0a0a____&parentid=249def484523a010VgnVCM1000000a0a0a0a____ Finance for non finance Knowledge horizon book Financial ratios, viewed 10 October 2009 at http://www.financialmodelingguide.com/financial-ratios/financial-ratios/ Harvard University budget types http://able.harvard.edu/fbud/qr/db101q/ Market Research Reports, viewed 5 November 2009 at http://www.bharatbook.com/Market-Research-Reports/Booming-UAE-Telecom-Sector.html Marshall, DH, McManus, WW, & Viele, DF 2000, Accounting: What the numbers mean, 5th edn., McGraw Hill-Irwin, NY Needles, Jr. BE, Powers, M, Mills, SK, & Anderson, HR 1999, Managerial accounting, 1999, 5th edn., Houghton-Mifflin, Boston, MA Pinches, GE 2000, Essentials of Financial management, 2nd edn. Tracy, JA, 2004, Financial and management accounting; An Introduction VI. Appendices Appendix A - Income statemeant Appendix B - Balance Sheet Appendix C - Cash flow statement Appendix D - Actual and Budgeted Balance Sheet Appendix E - Actual and Budged Income Statement Appendix F -Worst Case and Best Case scenarios Appendix G - Discounted Cash Flow Appendix H - Report to Management APPENDICES Appendix A Income Statement with Common-size statements (2008 and 2007) and percentage changes. (Vertical and horizontal analysis) Income Statement       2,008 Common-size IS 2,007 Common-size IS Percentage change AED000 2008 AED000 2007 Revenue 12,865,894.00 100 10,433,779.00 100 23 Operating profit 3,975,529.00 38 3,297,862.00 32 28 Other income 280,502.00 2 119,780.00 12 133 Profit for the year 4,256,031.00 32 3,417,642.00 33 25 Unappropriated profit brought forward 35,275.00 1 17,633.00 0.2 105 Net Profit 4,291,306.00 33 3,435,275.00 33 25 Appropriations: Dividends (1,815,000.00) 14 (1,650,000.00) 16 10 Transfer to development reserve (500,000.00) 4 (500,000.00) 5 0 Transfer to asset replacement reserve (500,000.00) 4 (500,000.00) 5 0 Transfer to general reserve (1,400,000.00) 18 (750,000.00) 8 86 Unappropriated profit carried forward 76,306.00 0.6 35,275.00 0.3 117 Earnings per share  AED 1.17 AED 0.94 Appendix B Balance Sheet with Common-size Statements (2008 and 2007) and percentage changes. (Vertical and horizontal analysis) Etisalat Balance Sheet Dec 2008 Common-size BS 2008 2008 AED0000 Common-size BS 2007 2007 AED 0000 Percentage change ASSETS Non-current assets Fixed assets 54 8,480,300 65 8,605,542 -1.5 Investments in associated undertakings 14 2,207,715 15 1,946,018 13 Other investments 365,210 226,672 68 loans to associated undertakings 1 35,472 2 - Inf Total non-current assets 78 11,088,697 81 10,778,232 3 Current assets Stores 1365 104,545 86,386 21 Debtors and prepayments 13 2,843,779 12 1,568,799 31 Loans to associated undertakings 8,868 6,980 26 Amounts due from other telecommunications administrations 350,946 141,496 58 Bank and cash balances 61 9,658,510 54 7,801,763 24 Total current assets 82 12,966,648 72 9,605,424 35 Liabilities Current liabilities Creditors and accruals 38 5,955,377 36 4,829,111 23 Amount due to other telecom- munications 8 1,049,330 8 1,041,712 8 Proposed dividend 6 907,500 5 825,000 4 Total current liabilities 57 7,912,207 57 6,695,823 13 Net current assets 32 5,054,441 22 2,909,601 74 Non - current liabilities Provision for staff terminal benefits 3 416,832 3 402,558 3 TOTAL NET ASSETS 100 15,726,306 100 13,285,275 13 Shareholders Equity Share capital 23 3,630,000 25 3,300,000 10 Development reserve 28 3,300,000 21 2,800,000 18 Asset replacement reserve 22 3,400,000 22 2,900,000 17 General reserve 34 5,320,000 32 4,250,000 25 unappropriated profit 0.4 76,306 0.3 35,275 11 TOTAL STOCK-HOLDERS EQUITY 100 15,726,306 100 13285275 13 Note: Discrepancies in totals are due to rounding. Appendix C Cash flow statements, 2008 & 2007 2008 AED.000 2007 AED.000 Cash Flows from Operating Activities Operating profit 3,975,529 3,297,862 Adjustments for: Depreciation 1,372,873 1,236,096 Capital Project written off 10,882 191,490 Net Transfer to staff Terminal benefits 14,274 33,500 Share of results of associated undertakings 251,312 (14,244) Changes in working capital: Stores (18,159) 7,624 Debtors and prepayments (1,274,980 (815,905) Amounts from/ to other telecommunications administrations (201,832) 116,236 Creditors and accruals 1,126,266 484,649 Net cash provided from operating activities 5,256,165 4,537,308 Cash flows from investing activities: Investments made during the year (651,547) (1,842,890) Purchase of fixed assets, net (1,258,513) 1,363,729) Net Cash used in investing activities (1,629,558) (3,086,839) Cash Flows from Financing activities Loans to associated undertakings (44,340) - Loan installments repaid by associated undertakings 6,980 9,505 Dividends paid (1,732,500) (1,575,000) Net Cash used in financing activities (1,769,860) (1,565,495) Net increase /(decrease) in cash and cash equivalents 1,856,747 115,026 Cash and cash equivalents at 1 January 7,801,763 7,916,789 Cash and cash equivalents at 31 Dec 9,658,510 7801763 Appendix D Actual and Budgeted Balance Sheets of the Company Etisalat Balance Sheet Dec 2008 ACTUAL BUDGETED Variance   2008 AED000 2008 AED 000 AED 000 Assets Non-current assets Fixed assets 8,480,300.00 9,000,000.00 519,700.00 Adverse Investments in associated undertakings 2,207,715.00 1,500,000.00 (707,715.00) Favorable Other investments 365,210.00 365,000.00 (210.00) Favorable loans to associated undertakings 35,472.00 - (35,472.00) Favorable       Total non-current assets 11,088,697.00 10,865,000.00     Current assets Stores 104,545.00 105,000.00 455.00 Adverse Debtors and prepayments 2,843,779.00 2,500,000.00 (343,779.00) Favorable Loans to associated undertakings 8,868.00 7,000.00 (1,868.00) Favorable Amt. due fm other telecom adminis 350,946.00 300,000.00 (50,946.00) Favorable Bank and cash balances 9,658,510.00 9,365,500.00 (293,010.00) Favorable       Total current assets 12,966,648.00 12,277,500.00 Liabilities Current liabilities Creditors and accruals 5,955,377.00 5,000,000.00 (955,377.00) Favorable Amount due to other telecommunications 1,049,330.00 1,100,000.00 50,670.00 Adverse Proposed dividend 907,500.00 907,500.00 - Favorable       Total current liabilities 7,912,207.00 7,007,500.00         Net current assets 5,054,441.00 5,270,000.00   Non - current liabilities Provision for staff terminal benefits 416,832.00 410,000.00 (6,832.00) Favorable       Net assets 15,726,306.00 15,725,000.00   Shareholders Equity Share capital 3,630,000.00 3,630,000.00 - Favorable Development reserve 3,300,000.00 3,300,000.00 - Favorable Asset replacement reserve 3,400,000.00 3,400,000.00 - Favorable General reserve 5,320,000.00 5,320,000.00 - Favorable unappropriated profit 76,306.00 75,000.00 (1,306.00) Favorable       Total shareholders Equity 15,726,306.00 15,725,000.00 Appendix E Actual and Budgeted Income Statements Income Statement ACTUAL BUDGETED Variance   2008 AED000 2008 AED 000 AED 000     Revenue 12,865,894.00 12,000,000.00 (865,894.00) Favorable Operating profit 3,975,529.00 3,855,000.00 (120,529.00) Favorable Other income 280,502.00 400,000.00 119,498.00 Adverse Profit for the year 4,256,031.00 4,255,000.00 (1,031.00) Favorable Unappropriated profit brought forward 35,275.00 35,000.00 (275.00) Favorable 4,291,306.00 4,290,000.00 (1,306.00) Favorable Appropriations: Dividends (1,815,000.00) (1,815,000.00) - Favorable Transfer to development reserve (500,000.00) (500,000.00) - Favorable Transfer to asset replacement reserve (500,000.00) (500,000.00) - Favorable Transfer to general reserve (1,400,000.00) (1,400,000.00) - Favorable Unappropriated profit carried forward 76,306.00 75,000.00 (1,306.00) Favorable Appendix F Pro-forma budgets, worst-case and best-case scenario Assumptions used. The options chosen for the ‘worst case’ are as follows: a) An annual projected decrease for this year in sales by 11% b) An immediate annual projected plant/machinery cost increase by 17% The options chosen for the ‘best case scenario’ are as follows: a) A projected annual increase in sales by 23% b) An immediate annual investment increase by 6.5% The underlying assumptions for both cases are as follows: 1. The base is year 2008, basis which we have made our changes in the proposed budget for 2009. 2. The balancing figure in the balance sheet has been adjusted in the Debtors due to the fluctuation of the sales revenue under both the circumstances. 3. With the increase or decrease in sales, the operating profit has also been adjusted likewise. Appendix G DISCOUNTED CASH FLOW RATE OF RETURN Table and Calculations NPV Calculations at 12% Rate of Return Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Cash flow (1,200.00) 800.00 1,200.00 1,200.00 1,200.00 2,000.00 Less: Operating Expenses (320.00) (480.00) (480.00) (480.00) (800.00) Less: Depreciation   (200.00) (200.00) (200.00) (200.00) (200.00) Profit Before Tax (1,200.00) 280.00 520.00 520.00 520.00 1,000.00 Less: Tax @ 30%   (84.00) (156.00) (156.00) (156.00) (300.00) Profit after Tax (1,200.00) 196.00 364.00 364.00 364.00 700.00 Add: Depreciation   200.00 200.00 200.00 200.00 200.00 Operating Cash Flow (1,200.00) 396.00 564.00 564.00 564.00 900.00 PVF @12% 1.0000 0.893 0.797 0.712 0.636 0.567 Present Value (1,200.00) 354 450 401 318 590 Add: Terminal Cash Flow (recovery of working capital) 140 Total PV of cash inflow 2113 NPV 913 IRR 36.45% Discounted Payback 2.42 years IRR Calculations at 40% Operating Cash Flow (1,200.00) 396.00 564.00 564.00 564.00 900.00 PVF @40% 1.0000 0.893 0.797 0.712 0.636 0.567 Present Value (1,200.00) 0.716 0.510 0.364 0.260 0.186 Add: Terminal Cash Flow (recovery of working capital) 140 284 288 205 147 193 Total PV of cash inflow 1117 IRR Calculations at 35% Operating Cash Flow (1,200.00) 396.00 564.00 564.00 564.00 900.00 PVF @35% 1.0000 0.893 0.797 0.712 0.636 0.567 Present Value (1,200.00) 0.741 0.549 0.406 0.301 0.223 Add: Terminal Cash Flow (recovery of working capital) 140 284 288 205 147 193 Total PV of cash inflow 1234 Interpolation: 1234 - 1200 = 34 1234 - 1117 = 117 34/117 = 0.295 (5%) = 1.45% 35% + 1.45% = 36.45 (Internal Rate of Return) ----------------------------- Assumptions: Initial Cost of the Project AED 1,000,000,000 Working Capital Required AED 200,000,000 Life of the project 5 years Financed through Equity share capital Cost of Equity 12% Rate of Depreciation on capital assets 20% with no residual value Operating Expenses 40% of the sales Rate of Tax 30% (Assumed to be applicable in other countries in which Etisalat wishes to make investment) Cash Flow of the Project: Year 1 AED 800,000,000 Year 2 AED 1,200,000,000 Year 3 AED 1,2,00,000,000 Year 4 AED 1,200,000,000 Year 5 AED 2,000,000,000 (in AED million) Appendix H Report to Management Sir : I wish to thank you for the opportunity to conduct a study on the financial and budgeting aspect of the opeations of Emirates Telecommunications Corporation. My study covered an assessment of the companys financial condition and the implemeantation of a Master Budget (consisting of the budgets for the income statement, balance sheet, and cash flow) for the one-year period ending December 31, 2008. My study revealed that Etisalat was stable and profitable, indicating superb management of resources at the disposal of company executives. The Board of Directors showed great prudence, wisdom, and vision in going forward extending the scope of business beyond United Arab Emirates, beyond the Middle East, and towards Africa, Asia, and other parts of the world. I wish to point out, however, that there was a slight decline in incremental investments in fixed assets, which however shows prudence in the absence of more profitable opportunities. Once such opportunities present themselves, I am sure that the management will more aggressive in its policy of expansion and diversification overseas. To improve profitability, I believe that it is important, first of all, to look into generating more business in order to expand revenues. At the same time, the management should look into ways to utilize its resources more efficiently and more economically, thereby improving the bottom line. Also there is a need to always look towards the long-term future so that current decisions shall not be made at the expense of the company long-term prospects. My investment proposal shows that the projections of cash inflows from the operation of the project for the next 5 years is on the optimistic. A return of 36+ per cent is rather optimistic. I would suggest that the assumptions be re-examined, or at least a simulation where assumptions are varied so that they would reflect probable realities, be made in a series of new calculations. Such changes may be in the shape of adverse changes in the societal environment (economic, social, legal, political, technological, demographic, and so on). In that way, management would be able to anticipate them and prepare contingent plans in case most of such assumptions turn out to be true. Once again, thank you for the opportunity to be of service. Sincerely, Read More