A strategic approach to IT budgeting
Organizations
of all types struggle with information technology (IT) budgeting.
This often happens because the IT team doesn’t understand the
budgeting process and the finance team doesn’t understand IT. CPAs,
whether in public practice, business and industry, the
not-for-profit sector or government, can remedy this disconnect by
changing their organization’s approach to IT budgeting from merely
an annual “make it fit” exercise into a meaningful planning and
ongoing management process.
This
shift requires more than just throwing numbers onto a spreadsheet.
It demands that an organization’s leaders work together to define
IT’s role in achieving the organization’s objectives—transforming IT
from a cost center into an investment.
GOOD
IT BUDGETING IS LIKE GOOD FINANCIAL PLANNING
If
you look at IT spending as an investment in your organization’s
future, you may see that effective IT budgeting has much in common
with personal financial planning. To give appropriate savings and
investment guidance, personal financial planners first must
understand their clients’ short- and long-term goals. The same holds
true for CPAs working on an IT budget. Only after gaining an
understanding of the organization’s short- and long-term goals can
CPAs help ensure that the organization is aligning its IT strategy
with its business strategy, resulting in the right IT investment decisions.
Personal
financial planners must consider each client’s short- and long-term
constraints—for example, is the client’s ability to save or invest
limited by current earnings, deduction limitations or even current
life-stage expenses (for example, school costs for children)? A
similar concern with constraints applies to IT budgeting. What is
the organization’s cash flow? How will IT spending impact the
organization’s overall capital and operating budgets? Are any major
projects occurring that might impact the IT infrastructure? Remember
to consider both the financial and nonfinancial implications of
IT-related initiatives.
Good
financial planning considers the human element of each client’s
life. What is the client’s current lifestyle, and what is the
client’s expected lifestyle upon retirement? Is the client willing
to make changes in his or her current lifestyle to provide for a
different lifestyle upon retirement?
The
human element also is one of the key, and most often overlooked,
aspects of IT initiatives. Is the organization making other changes
that might impact its employees’ ability to absorb a new computer
system or other IT investment? How would an IT initiative affect
employees’ work lives?
Good
personal financial planners help clients look at various investment
options and savings strategies to determine what makes the most
sense based on each client’s life stage, risk tolerance and savings
ability. Financial planners discuss multiple investment and savings
scenarios with clients to determine what best meets their short- and
long-term needs. From this process comes the final financial plan.
CPAs
should develop their organization’s IT budget in much the same way.
They should use multiple versions of the IT budget to analyze
technology options and their associated financing strategies. They
should look at each IT initiative as an investment option, the
timing and execution of which affects the overall IT budget. They
should consider different timing or initiative phasing to identify
how different execution scenarios might impact the organization’s IT
budget and cash flow.
ALIGNING
THE IT BUDGET WITH THE ORGANIZATION’S STRATEGY
Once
a client’s individual investment and savings options have been
selected, good financial planners look at the plan as a whole to
determine whether it will achieve the client’s financial goals. The
IT budget works the same way. Once IT initiatives have been
evaluated and incorporated into the budget, organizations should
take a step back from the details and look at the big picture.
Each
organization should answer the following questions: Do the selected
IT initiatives align with and support the organization’s strategic
objectives? Should any initiatives that weren’t selected for the
budget be reconsidered? Would any of the organization’s strategic
initiatives make one of the selected IT initiatives obsolete?
The
next step is to validate IT’s role in the organization. The IT
budget often is treated as just one big mass (see sidebar “IT
Budgets: Expenditure Types and Categories,” near bottom of page).
However, it really has three distinct components. Information
technology research firm Gartner refers to these components as Run,
Grow and Transform.
1.
Run
budget
items keep the organization operating. Examples of Run budget items
include mission-critical server replacements, key software upgrades
and personnel costs associated with administering and maintaining
the IT infrastructure on a day-to-day basis.
Organizations
that have to trim IT budgets should avoid cutting Run initiatives.
Such cuts would introduce operational risk. If an organization
already is going through a tough stretch, the last thing it needs is
a server, application or network failure.
2.
Grow budget items help the organization introduce new
capabilities or improve existing ones. Grow initiatives could
include the implementation of new software that makes operations
more efficient, the purchase of a new firewall that provides
additional protection from cyber threats or an upgrade of the
organization’s website that improves interactivity with customers.
Grow
budget items should tie directly to the organization’s strategic
initiatives. Grow initiatives usually are not as mission critical as
Run initiatives and often have some time flexibility, which means
that they are good candidates for starting early when additional
cash is available, or for deferral if cash is tight.
3.
Transform budget items are research-
and-development-type activities. These initiatives might seek to
identify, for example, the right technologies for new organizational
capabilities; fundamental changes to business processes; or a new
product or service offering. Examples of Transform initiatives
include proof of concepts, prototypes and small-scale testing of new
systems or business applications.
When
finances are tight, transform initiatives often are the first to be
cut or deferred—unless they are associated with key strategic
initiatives that the organization views as essential to its
continued operation. Even if the organization doesn’t deem certain
Transform initiatives immediately essential, care should be taken
when considering cutting or deferring them. That’s because Transform
initiatives often are key to the organization’s long-term health.
Failure to provide adequate resources to Transform initiatives can
stunt an organization’s future success. By looking at the
percentages of the Run, Grow and Transform components of an IT
budget, CPAs can analyze the role that IT plays in the organization
(see sidebar “Run-Grow-Transform IT Investment Analysis”). A
Run-Grow-Transform analysis can determine whether the IT budget
properly reflects IT’s designated role in achieving the
organization’s mission. Additionally, by classifying initiatives
into each of these categories, CPAs can help guide adjustments to
the timing of IT spending in response to changes in the
organization’s cash position throughout the year.
Run-Grow-Transform IT Investment Analysis
By
analyzing the Run-Grow-Transform components of an organization’s
IT budget, CPAs can help to ensure a balanced IT investment.
Just as a diversified financial portfolio is good for long-term
financial health, a diversified IT budget portfolio is important
for ensuring the long-term viability of an
organization.
In
Exhibit 1, Entity A (a late technology adopter) is an
organization where IT does not play a critical role. About 80%
of the IT budget is used for “keeping the lights on,” and only
20% is spent helping to grow the organization. Conversely,
Entity B (mainstream adopter) and Entity C (early adopter) spend
only 50% to 60% of their IT budget on Run items and devote a
hefty 30% to growing their IT capabilities. The key difference
between these two organizations is that Entity C devotes twice
as much of its IT spending to Transform initiatives as Entity B
does. While this might not seem like much, spending more than
your competition to figure out how to leverage technology can
provide a huge competitive advantage.
How
important is IT to your organization? If it is critical or very
important, your IT spending analysis should look like those of
Entity B or C. Be wary if your breakdown looks like Entity A’s.
In today’s world, if your organization isn’t transforming and
keeping current with technology, you might be left in the
proverbial silicon dust.
ASSESSING THE FINANCIAL IMPACTS OF THE IT
BUDGET
CPAs
also can help determine whether the IT budget makes financial
sense. In making that determination, the following
considerations are key: (1) impact on financial key
performance indicators (KPIs); (2) impact on financial
statements; and (3) impact on cash flow. Because IT budgets
often have large capital- and operating-expenditure
components, the final IT budget needs to be incorporated into
the organization’s overall budget to determine whether the
timing or financing options for IT initiatives could have any
unintended consequences.
Each
organization uses different financial KPIs to gauge its
performance. Loan covenants, leasing agreements, contracts and
grants, and other arrangements also may have certain financial
requirements or metrics that should be considered when
developing the IT budget. Sometimes, adjustments to the timing
of initiatives or different financing arrangements for the
initiatives can help to ensure that an organization meets both
its compliance requirements and internal KPI
measurements.
Finally,
and most importantly for smaller organizations and
not-for-profits, CPAs must consider the impact on cash flow.
IT initiatives often have large upfront expenditures for
purchase and implementation. Organizations can manage the
impact of these initiatives on their cash flow by, again,
adjusting the timing of the initiatives (or purchases within
the initiative) or by obtaining different financing
arrangements.
One
way to manage cash flow is to use a reserve approach to IT
budgeting. Similar to the way reserve requirements are
computed for a homeowners’ association, an organization can
plan to set aside cash each year to ensure that it has the
funds necessary to execute future IT initiatives. This process
also helps reduce the risk that an unexpected technology
failure and early replacement would have a negative impact on
the organization’s cash flow.
Again,
a long-term outlook is advisable. CPAs should assess the IT
budget’s financial impact not only for the current or upcoming
year, but also for future periods that IT initiatives might
affect. Too often, organizations “balance the budget” for the
current year, only to run into unintended consequences in a
future period. Remember, a good IT budget balances both
short-term and long-term financial implications. The sidebar
“A Multiyear Run-Grow-Transform and Reserve Analysis”
illustrates how reserve budgeting works.
A Multiyear Run-Grow-Transform and Reserve
Analysis
Exhibit
2 shows how a small organization may have different
Run-Grow-Transform profiles as it goes through different
stages in its development.
In
2011, the organization “modernized” its IT infrastructure,
spending a substantial amount to replace and update its
servers and workstations. Over the next two years, it
plans to scale back its IT spending to build up reserves
for major upgrades in 2014 and 2015. In 2016, the
organization plans to start building reserves for the next
major upgrade/replacement cycle.
The
same small organization can use a reserve analysis to
smooth out the impact of IT spending on its budget and
manage cash flow. The average annual spending ($85,139)
identified in Exhibit
2 is used as the IT budget amount for 2012–2016. This
results in reserve-amount deficiencies in 2012 and 2015,
as shown in Exhibit
3. That means the organization must plan to supplement
its IT budget with about $4,300 in 2012 and $2,700 in 2015
to balance its budget and spending, as shown in Exhibit
4.
Once
the additional funding amounts are plugged in, the
projected IT spending is fully covered for the out-years
with only minimal additional contributions of cash. Such
contributions often are much easier to manage than large
fluctuations in cash, especially for small businesses and
not-for-profits. When the projected spending is less than
the budgeted amount, the difference for that year goes
into a “reserve” that accumulates over time to balance out
cash needs in years with significantly larger projected
spending. The organization can plan to “hold back” in
years prior to large spending years to accumulate more
cash reserves, as seen in Exhibit
4 when 2013 is compared with 2014 and 2015. Please
note that this reserve analysis is purely a budgeting and
cash management technique and is not valid for financial
statement purposes.
CONCLUSION
When
CPAs employ a strategic approach for IT budgeting, they
create a planning and decision-making tool that can help
maximize the benefits of IT investments. A good IT
budget not only gives the organization the ability to
manage its IT costs in both the short and long term, but
it also provides the agility needed to adjust IT
spending in response to changes in the business
environment. In the final analysis, a good IT budget
provides a competitive advantage because it helps
organizations better execute in achieving their
missions. CPAs should play a critical role in helping
their organizations gain this competitive
edge.
Click
here to view a video clip of Donny Shimamoto,
CPA/CITP, discussing the strategic approach to IT
budgeting.
IT Budgets: Expenditure Types and
Categories
Sometimes,
IT budgets are treated as one big blob. To support
better decision making and planning, the IT budget
should identify expenditures by type and
category.
In
addition to the standard personnel and nonpersonnel
expenditures associated with other functions, the IT
budget should identify the following IT-specific
expenditures:
IT
budgets also should address the three main
categories of IT spending:
Identifying
the categories of expenditures helps to break the IT
budget blob into identifiable components that can be
used to support organizational planning and cost
management.
Not-For-Profits Face Grant
Decision
Not-for-profit
organizations have an additional variable to
consider when looking at IT initiatives: grant
opportunities.
Many
grants fund one-time capital expenditures but
not ongoing operational expenditures.
Not-for-profit organizations also must consider
funding sources and grant opportunities when
structuring IT budgets to ensure that proper
funding is provided for both the capital and
operating portions of all projects.
Often,
not-for-profits jump to take advantage of a
grant opportunity but forget to assess the
impact on their operational budget. CPAs working
with a not-for-profit should insist that this
step is taken to ensure that the not-for-profit
can absorb the ongoing expenditures in its
operations funding.
EXECUTIVE SUMMARY
Organizations
of all types often struggle with IT
budgeting
because
the finance team doesn’t understand IT and the
IT team doesn’t understand budgeting. One way
for both sides to better conceptualize the
process is to look at IT spending as an
investment in the organization’s
future.
A
good IT budgeting process has much in common
with good personal financial planning.
Both processes establish short- and long-term
goals, take into account spending and other
constraints, consider the “human” impact and
analyze several strategies to determine the
approach that aligns best with mission and
risk tolerance.
While
often viewed as one big mass, an IT budget
comprises many components
—such
as capital, operating and project
categories—and types of spending—such as
hardware, software, subscriptions and
services.
A
good way to analyze the IT budget is to
conduct a Run- Grow-Transform analysis.
“Run”
budget items “keep the lights on”; “Grow”
spending aims to increase the organization’s
IT proficiency; and “Transform” projects refer
to R&D-type projects such as proof of
concepts or prototypes.
CPAs
can determine whether the IT budget makes
financial sense
by
assessing its impact on three areas: financial
key performance indicators (KPIs), financial
statements and cash flow.
The
reserve approach to IT budgeting helps
organizations manage cash flow.
The
technique is similar to the system used by
many homeowners’ associations. The strategy is
especially useful for smaller entities and
not-for-profits, which have less cash on hand
for large technology
expenditures.
Donny
Shimamoto
(donny@intraprisetechknowlogies.com)
is managing director of
IntrapriseTechKnowlogies in
Honolulu.
To
comment on this article or to suggest an
idea for another article, contact Jeff Drew,
senior editor, at jdrew@aicpa.org
or 919-402-4056.
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