IT Financial Management: The Business of IT

This chapter is from the book

Business of IT, The: How to Improve Service and Lower Costs

Learn More Buy

This chapter is from the book

This chapter is from the book 

Business of IT, The: How to Improve Service and Lower Costs

Learn More Buy

Financial management of Information Technology (IT) resources is a powerful process to improve service while lowering costs. Simply stated, IT financial management is the process of overseeing IT expenditures, with the goal of providing both business units and IT departments with a common framework to evaluate services and plan for future investments to optimize IT spending.

As technologies become more complex, the financial management of IT investments has proven challenging. Many IT organizations lack financial management experience. Similarly, business units often lack a clear understanding of the technology enabling a given IT service. As a result, many organizations find it challenging to develop a budget to expand a given service, account for key costs, or charge for services. Many organizations lose opportunities to maximize their return on investment (ROI) for IT resources as the management of budgets and tracking of IT utilization and costs fail to occur.

With worldwide IT spending estimated to exceed $3 trillion in 2009 according to the Gartner Group, the potential benefit of maximizing this spending is substantial.¹ Many governments, businesses, and nonprofit organizations have recognized the growing importance of IT financial management. In a recent Interactive Data Corporation (IDC) survey of 600 IT organizations worldwide, respondents cited "cost/budgets/financial concerns" as the top priority needs for IT supported businesses.²

This chapter provides a tactical roadmap illustrating how to improve specific IT financial management practices based on best practices, including Information Technology Infrastructure Library (ITIL)^®. First, we summarize the need to structure financial management activities based on an organization's IT services. Aligning financial management activities with IT services helps IT organizations to account for charge, and budget for services based on customer demand.

We then summarize the three basic IT financial management activities—budgeting, accounting, and charging—an organization should have in place to cost-effectively deliver services that customers value. While ITIL now provides guidance on a range of effective and value added financial management activities to improve service and lower costs, we spend a significant amount of time on these basic activities because many IT organizations lack the ability to budget, account, or charge for the value of services. Without effective budgeting, accounting, and charging activities, an organization cannot effectively undertake these value added activities to improve service and lower cost.

After summarizing the activities and benefits of basic financial management activities, we discuss how the information can be used to improve service and lower cost through more advanced IT financial management activities, including service valuation, service provisioning, cost optimization, service investment analysis, and demand modeling. For example, by using accurate IT accounting information, an organization can effectively value the service to satisfy its customers, manage demand, and maximize the return of its IT investments through service portfolio management. This discussion of value added financial management activities also continues in Chapter 5, "IT Business Cases: Realizing IT Value."

Define Service-Based IT Financial Management Activities

IT financial management helps an IT organization determine the financial value of IT services provided to its customers. ITIL refers to this activity as service valuation, whereby each service is valued based on the cost of the service and value added by both the IT service provider and the customer's own assets.

Service-based IT financial management aligns the basic activities, accounting, charging, and budgeting, with other customer facing ITIL processes. For example, the IT organization tracks expenses against the services outlined in the service catalog on a continuous basis through the IT accounting. Similarly, IT budgeting generally consists of an annual or multiyear effort that measures existing financial commitments and estimates future expenses related to its services. Because most IT organizations need to recover costs or generate a profit, they implement a charging process, and customers are billed for the IT services that they consume.

Accounting, charging, and budgeting activities provide critical outputs and improve service through investing in the high-value services through rigorous service investment analysis, business cases, and portfolio management. Similarly, these outputs can lower costs through monitoring expenses related to a given service and determine whether it can be provided more effectively, referred to as service provisioning optimization in ITIL. We first define these basic financial management activities in the following subsections.

IT Accounting

IT accounting is the process of collecting financial information—both costs and benefits—for IT services and organizations. IT accounting helps the organization determine the financial cost, benefits, and risks of an IT service. IT accounting differs from traditional financial accounting in that it collects information based on an IT customer or service.³ IT accounting translates financial accounting information regarding assets, liabilities, revenue, and expenses in a framework that helps both the IT department and business units identify and track benefits and expenses related to specific IT services and customers. ITIL and other frameworks provide a range of guidance into grouping expenses; the three basic characteristics of an IT accounting framework are as follows:

• Cost and benefit types: The category of expenses (such as hardware, software, and staff) and benefits (such as contribution to net income)
• Cost classification: The end use or purpose of the expense, such as capital expense, direct or indirect cost
• Customer/service recording: The assignment of an expense or cost to a specific customer or service

Using these three characteristics, IT accounting assigns a cost type, cost classification, and service to each IT expense. Many different areas within the organization generate and consume IT financial information. For example, IT accounting for a particular IT service may draw information from a business unit, a project management organization, a corporate accounting department, and the IT department.⁴ As the IT accounting process becomes more mature, it brings together expense information from a range of sources within the organization to capture the actual cost and benefits of a given IT service.

IT Charging

Charging is the activity of billing internal or external customers for IT services. In some cases, the business unit, government organization, or nonprofit absorbs these costs through the organization's overhead or as a line item in its budget. However, as organizations improve their IT accounting practices, they develop a range of methods to charge or bill for IT services to achieve priority goals and identify the costs of a specific service. The IT charging activity combines the service's rate and the measure of consumption or utilization to create a bill or charge for the internal or external customer. Together, the rate and measure of consumption help the organization develop charges or assessments to recover total costs of providing a service or achieve target profit goals.

IT Budgeting

Effective IT budgeting identifies all future IT expenses related to a particular service, operation, or customer for a given period of time. Budgeting for IT expenses combines previous commitments, such as recurring hardware or software maintenance, and new expenses, such as additional staff to determine the resources for a given service or activity.

As with budgeting for any investment, IT budgeting is based on discounted cash flow methods. There is a time value to money. For an organization to make long-term investments using organizational resources, these investments must generate a positive financial return for the organization. Financial returns for investments are typically projected out for several years, and projected financial returns in future periods are discounted to current value using a discount rate determined by the organization. This results in IT expenditures being required to generate positive net present value (NPV), or positive value using other discounted cash flow methodology used by your organization. NPV and other discounted cash flow methodology are common methods for determining the financial value resulting from the investment of organizational resources.

Value Added Financial Management Activities

Accounting, budgeting, and charging are the basic IT financial management activities. Using the outputs from these activities, mature organizations can undertake a series of value-added activities to improve service and lower cost. We define these activities in this section.

As IT accounting and charging methods improve, the organization may use them to forecast demand for the services defined in the service catalog or in the underlying service pipeline. This information can then be used to develop appropriate capacity within the capacity management process. ITIL refers to this practice as demand modeling, which helps to ensure that an adequate level of service can be provided to customers. It also helps customers budget for specific services.

Demand modeling used in conjunction with charging can help the IT organization to influence customer behavior. For example, you can use lower "off-peak" billing rates to encourage customers to use IT services at specific times in the day. This influence can help IT service providers work with customers to avoid costly spikes in cost, for either the customer or the service provider. These practices are summarized in the charging discussion later in this chapter.

Mature IT financial organizations also use this financial management information to determine the benefits of financial investments made in IT projects through service portfolio management, service, and business cases. By understanding, tracking, and budgeting for sufficient resources, your organization can realize the level of value adequate to justify the use of organizational resources, time, and budget for the project. At the end of this chapter and continuing in Chapter 5, we discuss the use of business cases as a practice to best manage the service portfolio and invest in a given service.

Financial management information can also be used to improve the cost and service level through optimizing the costs related to the services in your service portfolio and evaluating alternatives based on these costs. This process, referred to as service provisioning optimization, can help organizations evaluate services that may generate revenue, but are exceeded by the commitment of resources to maintain these applications. We discuss these advanced activities at the end of this chapter.

Integrating Financial Management Activities

Effective accounting, charging, and budgeting practices are linked together through a continuous information flow. As shown in Figure 4-1, the IT budget predicts the budgeted amounts for the upcoming year, which the IT accounting process measures. The IT accounting process determines the cost of a given service, which provides critical information to the charging process. As an organization's financial management process matures, these practices will become increasingly linked.

Figure 4-1 Importance of integration between IT accounting, charging, and budgeting

The method for grouping IT budgeting items should be closely tied to IT accounting and charging activities. For example, Organization ABC has determined that its IT accounting cost types will be hardware, software, personnel, and facilities. The organization should use these cost types to develop its IT budget and forecast future expenses. By linking IT costs to the budgeting process, businesses can forecast their IT expenses and more easily prevent IT budget shortfalls.

Identifying Your IT Resources and Services

An inventory of IT resources and linking them to your services is the foundation of financial management and its key practices—accounting, charging, and budgeting. Through an effective process for identifying your IT assets, you can determine your resources, their cost, the charge for their use, and the budget for maintenance or improvement. In their recent book, The CMDB Imperative, Glenn O'Donnell and Carlos Casanova highlight a number of practical steps to developing this inventory. The authors discuss these topics extensively in their book, and we strongly recommend you consider these approaches as you implement a method, such as a configuration management database (CMDB), to manage your IT resources.

This list of resources also provides a critical link between IT operations, business units, and IT services. Figure 4-2 highlights how this understanding of your IT resources is the foundation for your IT financial management process.

Figure 4-2 An accurate inventory of your IT resources is the foundation of the key IT financial management processes.

Few organizations can define accurate cost data for all software applications, hardware, and networking equipment that enable their core business practices. According to recent academic research, almost two-thirds of chief financial officers (CFOs) and chief information officers (CIOs) do not know the size of their core software assets. A third of organizations do not know what they spend on these assets each year.⁵

To develop this inventory of your IT resources, you should first link financial management activities and tools. Chapter 2 summarizes many of the ITIL best practices, including using service catalog management to create an organization's IT service catalog and configuration management to create a CMDB. In each of the following areas, we link these financial management practices to the ITIL best practices highlighted in Chapter 2. This shows a key benefit of ITIL, namely the linkages between IT service level management and financial management.

We also recommend that you develop a standard process that links data within your organization. Although ITIL best practices suggest using a CMDB as a central repository of the location of IT assets, many IT organizations capture IT assets in stand-alone spreadsheets and software applications that are maintained by both the operational and financial organizations. This approach makes finding a central location of all required information difficult, if not impossible, for many organizations.

To link these spreadsheets, we recommend that the IT organization utilize financial expertise within its own organization or reach out to the overall organization's accounting staff to develop an organization wide list of IT resources. Together, they should:

• Establish a common format for collecting information on IT resources
• Formalize information-sharing organizational structure (such as monthly meetings) between the business units, accounting department, and IT department
• Clarify roles and responsibilities for collecting and maintaining customer and service information
• Automate collection of IT resources (inputs into the spreadsheets) wherever possible

An additional best practice is integrating usage and accounting information through an application that combines information about assets, usage, and accounting. For example, IBM's Tivoli^® Usage and Accounting Manager (TUAM) measures, analyzes, reports, and bills the utilization and costs of different IT resources. This tool can automate and consolidate your knowledge of both IT resources and their costs. These benefits are further discussed in the accounting and charging sections later in this chapter.