Demystifying IT Budegting

Few years ago I was asked to budget a new Software Project for a digital records system for a private organization along with several project managers and PMO analyst. To my surprise, I heard people saying they do not understand the accountability of IT expenditures. It is very common across small and big project teams, people misunderstanding the IT expenditures accounts and finally landing up in creating purchase orders which turn up an asset into a capital expenditure.

Most of the organizations do have in house IT Finance controllers who act as guardians to Project and Portfolio managers but sadly not all of them understand the basic CAPEX and OPEX accountability. IT managers might not understand the accounting disciplines and accounting folks might not know the underlying activities which derive IT expenses. IT managers usually give vague numbers based on face value to accounting folks which are then passed on to BUs and Stakeholders, eventually the BUs fail to account for what they are being invoiced.

IT expenditures are always driven through a demand and supply pipeline which is governed by the IT investment portfolios. An IT investment portfolio usually contains a mix of strategies required for decision making and funding.

Key areas of IT investment portfolio include:

·         Keeping the light on: 70-80% of the IT budget is allocated in this area to support operations of existing IT applications

·         Generating revenue: 10% of the annual budget goes in to generating revenue through IT enabled services

·         Regulatory compliance: 5% of the revenue might land up in meeting regulatory compliance criteria

·         Strategic Initiatives: Another 5% of the share might go into new initiatives for organizational excellence

Based on the above portfolio mix Projects and applications are proposed and funded maintaining the balance across all areas.

IT projects usually go through a strategic pipeline before they can be initiated and realised. Every IT project goes through following high level pipeline phases:

Idea -> Project Request -> Project Planning

An idea is realized like a new opportunity evaluation or by capturing new demand areas within the organization. A project request ends up in preparing a thorough business case for seeking executive or portfolio board's approval which might also involve cost benefit analysis and sale forecasting. Finally the project enters into planning phase where projects are budgeted and estimated with high level planning. It is in the Project planning phase when project managers are usually victimized for misleading and inaccurate budgets and estimates.

In theory the IT budgeting process can be executed in two strategic ways

·         Baseline budgeting

·         Zero-based budgeting

Baseline budgeting is a process of analysing previous year budgets and deriving current year budgets by adjusting actuals, inflation and forecasting activities and events for coming year. This process is usually fast enough but lacks encouragement to people for questioning the previous assumptions and outcomes. This leads to fairly low budgets without the idea of bringing new activities.

Zero-based budgets always start from scratch. There are no previous assumptions or cost drivers for upcoming budgets. This aids in detailed analysis of new activities and events with fair justification of all costs. The downside being it's fairly complex and time consuming activity. Also with the lack of IT accountability knowledge Zero-based budgets might introduce new complexities in the accounting systems.

I would now like to throw some light on the basic IT cost categories and budgeting rules. All IT projects are either delivered by in-house IT teams or ESPs (External service providers). They are then shelved on IT infrastructures either completely owned by the organization or virtually owned through PAAS, IAAS and SAAS cloud services. These IT projects are further supported by the IT operations team and operations activity continues till the lifetime of the application which might range from 5-10 years. Few organization also scale up their IT operations to IT services which then define service level agreements (SLAs) with a clear description of cost and delivery criteria.

During the entire cycle explained above all projects, applications and operations fall under following cost categories which eventually provides an input to IT budgeting:

·         Hardware

·         Software

·         People

·         External/Vendor Services

·         T&E (Travel and Entertainment)

·         IT Overheads

IT overheads usually include facilities, training, recruiting etc. Summing up all of these costs leads to the final IT budget cost for projects, services, and applications.

Now the question here is which part of the above mentioned cost categories should be capitalized and which of them should go into expenses?

The international regulations and accounting standards provide three main budgeting rules for IT budgets.

·         Preliminary project stage or evaluation phase, which establishes the technical feasibility of the project. This is charged to OPEX, because if the project ended here, there would be no asset to speak of.

·         Software development or application configuration phase. This is CAPEX, because the end result is an asset, comprising software (bought or built), hardware and infrastructure.

·         Post implementation or production phase. This is OPEX, because these are day-to-day running costs. Note that software license maintenance is OPEX, whereas the licenses themselves (previous point) are CAPEX.

The biggest mistake most project and portfolio managers do is to assume IT as a pure service or engineering discipline which I personally wonder shouldn't be the case. IT projects and portfolios are strategic and logical apart from being service and engineering driven

Few basic budgeting rules can be logically understood and applied across individual areas of the various architectural building blocks and ceremonies, for example:

·         Functional design - OPEX

·         Technical design - CAPEX

·         Platform and Application Upgrades and enhancements come uinder CAPEX

·         Maintenance and small changes are usually under OPEX

·         One-Time activities like Data Migration or Profile migrations are usually OPEX as they don't result in long term assets

·         T&E usually come under CAPEX but some of it might go into OPEX depending on the project/application phase

Above mentioned rules can further be tailored while implementing IT budgets so that all derived budgets adhere to IT accounting compliance and are easily auditable. Though the above budgeting rules might vary across geographies and organizations accounting rules, for example at some places and IT hardware procurement less than $5000 is considered as an OPEX wherein costlier procurements are considered as CAPEX