Winning the Budget GameHow to Get the Money You Need for IT Every Time

Nicole Forsgren, PhDAssistant Professor

Utah State University

Introductions

• A little about me• A little about you

• Balance Sheets• Income Statements• GAAP

We’ll leave that for the Accountants

This is NOT Financial Accounting

• Data-driven business decision making• Using any internal information to make better

decisions• Not just typical accounting information – even

though it’s all accounting information • Accounting information is:

• Information used to inform activities• Information used to control activities• Information used to judge or rate activities

This IS Managerial Accounting

• CapEx vs. OpEx• Important cycles and dates• Relevant decisions• Cost benefit analysis• Budgeting• Metrics• Comparing alternatives• Tools• Resources

What we’ll be covering

CapEx vs. OpEx• Capital expenditures (CapEx)

• What is capital?

• Operational expenses (OpEx)• Contracts and services• Supplies• Depreciation• Equipment refreshment – that doesn’t fall under CapEx

CapEx vs. OpEx

Are there any special rules, limits, or inclusions in your organization?

What are the breakpoints?

Can contracts for services be restructured so that OpEx CapEx?

CapEx and OpEx Takeaways

Important Cycles and Dates• What cycles does your company use?

• Product release• Budgeting• Purchasing• Hiring• Performance evaluations• Pay increases

• How do these cycles impact IT operations planning?

CapEx vs. OpEx

What dates are important to your organization?• Product release• Budgeting• Purchasing• Hiring• Performance evaluations• Pay increases

Put these on a calendar or something visible to your IT function

Cycles and Dates Takeaways

Relevant Decisions• Include

• Relevant, or “differential” information• Opportunity costs

• Do NOT include• Sunk costs

Cost Benefit AnalysisPresenting the cost of something vs the perceived benefit that results

• Assemble all costs• Estimate all savings or benefits• Ignore sunk costs

• Combine into similar analysis – all in same units– Traditionally in dollars; could be in cycle time, etc.

Cost Benefit Analysis

• Capital expenditures• Depreciation, lifespan

• Software + licensing, service• Labor to design, install, maintain• Space (power, cooling, colo leasing, network• Recurring maintenance• Decommissioning legacy hardware or service• Make sure costs are all in the same units

(generally $)

Assemble all costs

Cost Benefit Analysis

• Increased productivity, efficiency, sales• Reduced labor costs• Reduced maintenance/license fees

Additionally…• Costs of not doing it• Cost of failure• Cost of Plan B

Estimate all savings or benefits

Cost Benefit Analysis

• Human nature often reminds us of sunk costs• We often get preoccupied here• Management often gets preoccupied here

• This is its very own slide to call attention to a significant issue

Be careful to ignore sunk costs

BudgetingGetting a bigger portion of the budget

• Budgeting vs. profit planning• Continuous budgets• Understanding how budget impacts operations

Budgeting

• This is already done for each cost center. Is it coming from you?

• IT is a cost center, and will be evaluated based on your budget• “Cost center” isn’t a bad term; it’s an accounting

term

At organizational level, also called profit planning

Budgeting

• Month-by-month estimate of costs (often based on historical data and averages)

• Rolling budget – always have 12 months• Which means you should always be planning a

year out

Continuous budgets

Budgeting

• Cost of resources• Labor (plus overhead) biggest portion of your budget

• What is your overhead rate?• Other expenditures• New initiatives

Justifying expenditures requires a knowledge of cost and how they fit into the overall operations budget.

Understanding empowers you.

How budget impacts operations

Budgeting

• What budget categories are use it or lose it? • What categories roll over?• What is your fiscal year? Are there spending cutoff

dates?

Again, understanding empowers you.

How budget impacts operations

CapEx vs. OpEx

• What is your budgeting cycle? Who does it? Can you be involved? (Might be called “Capital Planning”)

• What is your labor overhead rate?• What categories of funds are use it or lose it? What

rolls over? • What is your fiscal year? What are your important

dates for spending?

Budgeting Takeaways

Metrics• Measuring yourself• Checking in

Metrics

• Recommended Reading: How to Measure Anything, Douglas Hubbard

Measuring Yourself

Metrics

• Benchmarking• Burn rate

• Tells you at what rate you are spending money

• Variance analysis (aka Standard costs)• Formal• Informal / making your own

Checking in

Evaluating Expenditures andComparing Alternatives• Communicating costs• Net Present Value• PV Index• Payback time• Internal Rate of Return

Evaluating Expenditures and Comparing Alternatives

• Cost of technical debt and refactoring• Cost to develop an in-house solution• Cost to maintain legacy systems• Hidden costs

Communicating Costs

Evaluating Expenditures and Comparing Alternatives

• Accounts for the time value of money• How to:

• Identify all revenue and expense impacts and when they will occur

• Identify a reasonable rate of return (from org: generally blend of creditor and owner costs)

• Calculate Present Value of each• Aggregate to find Net Present Value

• Can also be used to compare alternatives

Net Present Value

Evaluating Expenditures and Comparing Alternatives

Alternative 1

Net Present Value: 2 options

Alternative 2• Purchase new equipment,

$80,000.• Useful life is 5 years with $4,000

salvage value.• Incur $3,000 in training costs.• Will reduce annual operating

expenses by $21,500.• Replaces equipment with trade-

in value of $5,000.

• Purchase new equipment, $115,000.

• Useful life is 5 years with $30,000 salvage value.

• Incremental revenue $69,000 per year.

• Increase annual operating expenses by $32,000.

• A $20,000 major overhaul at the end of third year.

Desired rate of return is 14%

Net Present Value: Alternative 1• Purchase new equipment, $80,000.• Useful life is 5 years with $4,000 salvage value.• Incur $3,000 in training costs.• Will reduce annual operating expenses by $21,500.• Replaces equipment with trade-in value of $5,000.

Desired rate of return is 14%

0.519: from PV of $1 table, 5 years, 14%

3.433: from PV of an Annuity of $1, 5 years, 14%

Item Year Amount PV factor PV amountNew equipment 0 $(75,000.00) 1 $(75,000.00)Salvage 5 4,000.00 0.519 2,076.00 Training 0 (3,000.00) 1 (3,000.00)Savings 1-5 21,500.00 3.433 73,809.50 NPV $(2,114.50)

Net Present Value: Alternative 2• Purchase new equipment, $115,000.• Useful life is 5 years with $30,000 salvage value.• Incremental revenue $69,000 per year.• Increase annual operating expenses by $32,000.• A $20,000 major overhaul at the end of third year.

Desired rate of return is 14%

Item Year Amount PV factor PV amount

New equipment 0 $(115,000.00) 1 $(115,000.00)

Salvage 5 30,000.00 0.519 15,570.00

Increased revenue 1-5 69,000.00 3.433 236,877.00

Increased expenses 1-5 (32,000.00) 3.433 (109,856.00)

Overhaul 3 (20,000.00) 0.675 (13,500.00)

NPV $14,091.00

Net Present Value:Comparing Alternatives

Item Year Amount PV factor PV amountNew equipment 0 $(75,000.00) 1 $(75,000.00)Salvage 5 4,000.00 0.519 2,076.00 Training 0 (3,000.00) 1 (3,000.00)Savings 1-5 21,500.00 3.433 73,809.50 NPV $(2,114.50)

Item Year Amount PV factor PV amountNew equipment 0 $(115,000.00) 1 $(115,000.00)Salvage 5 30,000.00 0.519 15,570.00 Increased revenue 1-5 69,000.00 3.433 236,877.00 Increased expenses 1-5 (32,000.00) 3.433 (109,856.00)Overhaul 3 (20,000.00) 0.675 (13,500.00)NPV $14,091.00

Use PV Index:Inflows / Outflows

= 75,885.5 / 78000= 0.97

= 252,447 / 238,356= 1.06

1

2

Evaluating Expenditures and Comparing Alternatives

• Ignores time value of money• Good for “back of the napkin” calculations• Only use initial expenditure and annual cash inflows• Example: Alternative 1

• Initial investment $80,000• Reduce annual operating expenses by $12,500

• Payback period is 3.7 years

Payback Period

Evaluating Expenditures and Comparing Alternatives

• Recognizes time value of money• Using only initial expenditure and annual cash inflows,

tells you the rate of return for the project• Example: Alternative 2 (we know > 14%)

• Initial investment: $115,000• Net annual cash inflows: ($69,000-32,000)=$37,000• 5 year project

• Divide initial investment by cash inflows = 3.11• Refer to NPV annuity table ~18-19% returns

IRR: Internal Rate of Return

Spreadsheets

• Spreadsheet nightmares• Overly complex• Stale data: manually entered, nothing linked• Missing data

• Why are you using a spreadsheet?

Spreadsheets

Spreadsheets

• Basic rules of spreadsheets• Have a data source – single input area• Simple• Self-documenting• Use versioning• Clean use of constants and formulas• Check your output• Formatting output for readability

Spreadsheets

Spreadsheets

• A simple test• Can you understand it in 3 months?• Can someone who has never seen it understand

it?

Spreadsheets

Spreadsheets

• Pivot tables allow you to look at the same data multiple ways

• (go to example)

Spreadsheets

Resource Management• What are resources anyways?

• People• Hardware• Software• Power, space, cooling• Time

• Why do we care?• Requesting resources• Maintaining resources (includes time and $)• Use resources as a negotiating tool

Thank you!

nicolefv@gmail.com@nicolefvnicoleforsgren.com