Why It’s Critical to Understand IT Finance – Not Expense Management – in the Time of Corona

As organizations throughout the United States look toward a third quarter of COVID-influenced operations, it’s imperative to keep considering all the ways IT can act as steward for the business. Over the past couple months, Amalgam Insights has provided guidance for moving from survival mode to functioning in ways that conserve cash and save jobs. We’ve hosted webinars and published blogs covering everything from adjusting network resources to managing the nitty-gritty of cloud expenses. 

Now we begin to pull all of that together for a bigger picture. IT must support all newly remote staff as well as all network, mobility, cloud and SaaS costs, and stand accountable for every decision. And because it appears COVID-19 will be around for some time, the pressure to perform is nowhere near close to relenting. With the reality of another 6-12 months of operational challenges similar to what we currently face in this pandemic recession, Amalgam Insights aims to help IT level up to best prepare for top-level financial discussions. IT already handles expense management. Now it’s time to elevate, and understand and speak the language of IT finance. 

Clearing up Confusion

Before we go too far, let me clarify the term “IT finance.” Just because someone touches IT costs or expense does not mean they do IT finance. Most expense analysts work either with accounting or sourcing personnel, but rarely speak with the planning and budgeting personnel who hold the power of the purse. Expenses are the tactical, day-to-day entries that finance uses to calculate more strategic business metrics, such as cash flow, income, and business projections.

IT finance cares about the expense manager’s role to cut unnecessary costs and improve the organization’s cash flow based on the IT Rule of 30. Every unmanaged IT spend category averages 30% in waste. Waste crops up in circumstances including mergers and acquisitions, layoffs, furloughs, project changes, shifts in technology commitments, and so on.

In general, and the following will vary depending on vertical and profit levels, IT can save around 1% of bookings, which is equivalent to 5-6% of payroll or 15% of operating margin in the average enterprise, by cleaning up technology across the organization. How do you do that?

Review our blog on the 6 Stages of Managing COVID IT, as well as the subsequent insight we’ve provided. The takeaway now is that everyone should at least be in Stage 2 or 3.

Stage 1, in April, was all about survival. End users did what they needed to make sure they could work from home. Much of this they accomplished without following company policy. That’s valid and it’s okay. Still, the time has come to clean up, and enable and empower everyone to make good decisions. Part of that mandate includes making sure IT delivers insightful, meaningful input to CFOs and controllers. That’s where IT finance comes in.

What Is IT Finance?

Simply put, IT finance creates a shared vision of corporate health among IT, finance, and the rest of the business by looking at the planning, budgeting, and forecasting activities that highlight how people are using IT. That translates into giving employees the tools they need and aligning IT with revenue and key business goals. IT finance includes the following metrics that demonstrate what is happening with the costs that are saved or controlled through expense management:

  • Income: This is actual profitability based on receipts, Cost of Good Sold (COGS), SGA (Selling, General, and Administrative) Expenses, debt interest, and other relevant inputs.
  • Cash management: This deals with monthly cash flows and reflects the company’s current cash position and ability to conduct day-to-day business. IT departments in touch with finance can ask if cash can be reallocated back to IT or to other parts of the corporate budget while IT departments who are not part of this discussion will simply be treated as cost centers to be slashed to the bone.
  • Business outcomes: This gets into return on investment and payback periods (more on these topics below). The information tied to business outcomes justifies IT’s investments. 
  • Budgeting and forecasting: These practices show how IT costs are measured, and how they reflect demand within the organization.

Further, IT finance looks at cross-charging for IT assets and services to create more granular business plans and forecasts. This plays into the point about how end users put IT to work. To assess this, IT finance pinpoints every user/owner, cost center, profit center, department, location and project tied to each asset and/or service.

(Pro tip: Waste easily occurs when a user/owner moves among departments or leaves the organization, or when someone else takes over a project or resource. IT must record all such changes as it exits survival mode. Doing so not only will eliminate unnecessary spending, it also will provide the details for tracking how each cost rolls into the organizations’ finances.)

Understanding IT Finance’s Key Metrics

To speak the language of IT finance, it’s critical to know and present the following key metrics:  

  1. IT as Percent of Revenue. This metric displays the IT budget as a percentage of the organization’s overall revenue – all sales, receipts, etc. It then looks at how much of that revenue goes toward IT. Core IT tends to rank around 3% of an organization’s revenue with a great deal of variability based on verticals, geography, and company size.
  2. Operating Margin. Next, analyze actual profitability. On average, US companies average a profit margin of about 7%. Whether your margin is 1% or 20% makes a huge difference in what needs to happen operationally in planning your IT budget. 
  3. Payroll as Percent of Revenue. Taking the IT Rule of 30 into account, this metric means there is a chance to affectds 5-6% of payroll, on average. Controllers, CFOs and their teams may not spot this as an obvious opportunity, so IT must point this out and speak the language of finance.
  4. Return on Investment. This metric presents the ratio between net profit and investment cost from a project perspective. Many IT departments only know how to present either raw cost or the Total Cost of Ownership to their leadership and are poorly equipped to demonstrate or articulate potential business opportunities in the language of finance.
  5. Cost of Capital. This is how much it really costs the organization to use money and is typically tied to a company’s realistic expectations for growth over the next year.
  6. Net Present Value. Your finance team uses this metric already (and the next one) to identify opportunities. Net present value essentially boils down to discounted cash flows associated with a project, portfolio, or use case. 
  7. Internal Rate of Return. This metric estimates the profitability of an investment and can be used by finance to list a variety of projects across all areas of the business to determine which are most profitable.

Finance experts rely on the last two, NPV and IRR, extensively. Therefore, IT must provide these metrics because they help CFOs to understand everything in front of them – all the finances related to IT, HR, operations, sales and marketing, and so on. If IT does not provide NPV and IRR, the department will fall a step behind all the other lines of business that are treating their outputs in language finance understands. IT has the immense power to save jobs, the ultimate goal of 2020, but needs to articulate these opportunities in mature business terms.

Exploring ROI and Payback Periods in More Depth

Return on Investment and payback periods justify IT investments. For IT to get new technology funded, IT has to convince executives to fund technology that will support remote work and employees’ subsequent productivity and, as a result, boost the organization’s profitability.

Off the bat, know that “ROI” often gets misused. What means most to finance is the net return on investment; this is always a percentage. ROI on a project, then, must tally higher than the cost of capital.

(Pro tip: If IT cannot speak to how the ROI is higher than the current profit margin/rate of return, then finance will not sign off on an initiative. Another pro tip: Do not stretch ROI over too much time (i.e., 3, 4, 5, years). In fact, in today’s environment, anything with a payback period over 90 days is suspect and any ROI calculated over more than two years is making assumptions that nobody can truly predict. Address this situation by providing information on payback period.)

To that point, the unique circumstances of 2020 mean it is easier to look at spending from the view of payback period, or the time needed to get money back. As of right now look for rapid payback of three months or less. Anything more than that for the foreseeable future will make it harder to gain leaders’ buy-in.

Ways to Contextualize IT

Finance professionals assess three different categories to contextualize money. Really grasping the difference among these will give IT the acumen to rise from an expense to a finance mindset. As such, they are:

  • Income statement
  • Balance sheet
  • Statement of cash flows

Income Statement

This is the income the company (or department) has. Make sure to parse the difference between gross and net income. The latter represents cost of goods sold, sales and administration, and research and development; the former shows what the organization brought home. Note, however, that at this moment in history, finance experts are not so wrapped up in income/profit as a key metric. That may sound counterintuitive from a common-sense perspective but profit does not indicate cash on hand. Yes, profit influences valuations and stock prices, but throughout 2020, cash is king. Net income will help IT to show how its savings support bottom-line results.

Balance Sheet

These are all the assets and liabilities within the company (or department). The most common metric for showing this is Capital Expenditures (CapEx) vs. Operational Expenses (OpEx). From an IT perspective, show how spend plays into the CapEx and OpEx budgets. In the era of digital transformation and cloud, much of an IT department’s outlay will fall under the OpEx umbrella – which finance leaders often prefer. There is no depreciation or amortization associated with OpEx spending. In many cases, OpEx spending lends itself more easily to return-on-asset discussions. Though OpEx IT spending amounts to renting a service or asset, OpEx avoids the depreciation and inevitable replacment costs that CapEx provides (although OpEx spending comes with its own risks, such as uncontrolled usage). At any rate, providing data about return on assets can help finance understand in even more detail what IT is doing.  

Statement of Cash Flows

Cash flows show what is coming into the company (or department) and leaving it. 

This is the most essential context finance needs in 2020.

I cannot overstate this.

Organizations are living and dying by cash on hand. Do not just talk about cost optimization and moving CapEx expenses to OpEx. IT must know how all spending affects cash flow and be able to discuss that coherently and clearly with finance leaders.

Immediate opportunities to improve cash flow can be as extreme as paying bills late or asking for a bill “holiday” from vendors to keep cash in the interim. This is an artificial solution for maintaining cash in the short term if needed, and this level of cash management must be set up delicately with both executive approval and prior communications with vendors.  

Conclusion: Top Takeaways for IT Finance in 2020

To prepare for fruitful IT discuusions with the office of the CFO, address on the items on this checklist:

Act on the IT Rule of 30: This is the primary way to reduce costs in unmanaged areas. It’s especially important to apply this rule to cloud IaaS and SaaS because those are the two IT areas growing in 2020; all else will shrink by 5% or more.

Define ownership for all assets and services. Again, this is a clean-up exercise. Accept that shadow IT ran rampant throughout March and April and get to work fixing the mess.

Remember that finance amounts to more than cost management. Finance entails planning, income, cash flow and understanding how money is used in the organization. This goes far beyond basic costs and billing management.

Create a shared vision for corporate health. Now is the time to figure out what it means to cut costs responsibly to save and bring back jobs. IT and finance professionals need to work together on this. Be proactive, not reactive. 

Know how IT costs can affect key statements – income statement, balance sheet, and statement of cash flows. IT must understand how IT costs affect the business as a whole and when IT investments can exceed the value of their cost. This will make a big difference in discussions with finance professionals and allow IT to understand its impact on the company. IT professionals who just talk about costs and expenses without any context of potential value and business growth reduce their impact on the business because they position IT as a commoditized cost center. Basically, they sell their departments short. Provide context for what you’re doing.

Finally, provide the relevant metrics to justify IT investment. Right now everything has to be about cash management and saving jobs. Anything beyond that is nice if you’re one of the few companies going like gangbusters. But for most organizations, immediate payback period and cash are indispensable. Think about what will make an impact in 2020.

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If you are seeking outside guidance and a deeper dive on IT Finance, Return on Investment, and making the IT case to Finance, Amalgam Insights is here to help. Click here to schedule a consultation.

Join us at TEM Expo available on demand until August 13 at no cost to learn more about how to prepare for COVID IT and take immediate action to cut costs. In context of this topic, we recommend the following sessions: Robert Bracco and Dana Risley of MobiChord speak on the role of IT Financial Management, Planful CFO Shane Hansen speaks on the importance of cash management, and our Executive Panel digs into the IT Finance as a strategic tool for escalating the IT professional.

And if you’d like to learn more about this topic now, please watch our webinar on IT Finance.