IT Financial Management: The Business of IT

This chapter is from the book

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

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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

Improve IT Accounting to Value Services

We recommend that you align your IT accounting practices with the services in your service portfolio. This alignment will help you improve your IT accounting and provide you with a better understanding of the costs, benefits, and risks associated with each service. Determining the cost, benefit, and risks of each service can be complex. When an IT organization begins the process of identifying the costs associated with a service, it will need to consider alternative approaches to account for items other than the acquisition—costs such as power consumption, staff costs, and infrastructure. For example, with the rise of virtualization and enterprise servers, the process for establishing an service's share of the total server cost can prove difficult.

Because of these challenges, organizations face a choice about the degree of specificity regarding the cost of an IT asset. A simplistic cost estimate can focus on the initial acquisition cost and annual maintenance expense. A more inclusive cost estimate will use TCO, which we discussed earlier in this chapter.

To help you determine your approach to accounting for costs based on a service, we outline different options and provide an example of a simple hosting service. This example provides you with the context for our recommended approach.

Basic Approaches to Improve IT Accounting

In our IT financial management maturity model, the reactive organization, which reviews IT as an unpredictable cost, simply accounts for total IT costs. The reactive organization does not decompose expenses into cost types and linked with services. Any organization that is more mature than a reactive organization will have an IT accounting process that will:

1. Categorize expenses using cost types and cost classifications.
2. Assign costs to services through service recording.
3. Apply a consistent method for using actual costs, averages, or estimates.

Each of these steps is discussed in the following sections.

Categorize Expenses Using Cost Types and Cost Classifications

To develop cost types, we generally recommend that you develop basic types that can be applied consistently across your services. These costs will include hardware, software, maintenance, personnel (employee and contractor), miscellaneous personnel costs (training, awards, and so on), building and facilities costs, internal and external overheads, and supplies. These costs are decomposed into the following cost types:

• Hardware: This cost type includes the initial hardware purchase, depreciation, maintenance, installation, and any upgrades. This hardware includes servers, mainframes, storage (disk/tape), printers, load balancers, and other devices.
• Software: This cost type includes any software or application. It often includes the operating system, database and data management, messaging, middleware, ongoing patches, and upgrades.
• Infrastructure and environmental costs (nonsoftware): These cost types, including floor space at a data center, power, upkeep/maintenance, security, networking and Internet bandwidth, and supplies, can be substantial for an IT organization. As a result, many organizations develop average costs for a given asset, such as server racks, and distribute them across the data center.
• Staff costs: Many organizations use estimates of staff time allocated to a specific activity, such as provisioning a server or patching an application, to develop the cost. These estimates are often developed through interviews with staff about time incurred for conducting specific activities. These estimates can be confirmed by reviewing overall staff costs and infrastructure supported to determine whether these estimates appear reasonable. Alternatively, other organizations simply allocate a percentage of staff costs to a particular service without conducting specific time estimates per service. Mature organizations should evaluate historical time tracking data.
• Overhead: Organizations capture a number of operating cost types in the cost category of overhead. Included in overhead are a number of cost types, including management salaries and other expenses that are not specifically allocated to other cost categories. Many organizations group into the overhead cost category a number of unallocated costs that are not appropriate for infrastructure and environmental costs. Potential inaccurate cost allocations into overhead can cause significant confusion among the customers of IT organizations. Whenever possible, making specific cost allocations to cost types other than overhead is preferable to combining costs into overhead because it provides more transparent, actionable data to the customers.

Many organizations use several additional ways to group cost, which the ITIL refers to as cost classifications. These classifications depend on the organization's structure and IT accounting practices. These options include grouping costs by:

• Direct and indirect costs: Direct costs are those attributed to a specific service. Indirect costs are those costs that relate to a number of different services that cannot be exactly allocated between services. In some cases, indirect costs are simply included in an organization's overhead.
• Fixed and variable costs: Fixed costs are those that do not change based on the IT resource. For example, the maintenance cost or server cost would be a fixed cost. A variable cost example is staff costs, which might increase based on a given level of utilization.
• Capitalized costs: Although capitalized costs may span multiple cost types as defined previously and may vary based on the organization, they are a widely used cost accounting method to spread IT costs over time. Although these costs may be excluded like data conversion and prototyping, they may be important to your organization. Tracking these costs requires additional tracking during implementation, and you should work closely with your finance or accounting department.

As the IT accounting matures, cost types are classified in ways that add value to the organization and are increasingly aligned with key business decisions.

Assign Costs to Services through Service Recording

After developing your organization's cost types, you will group these cost types by a given service. Many IT organizations are technology focused, and as a result, their IT accounting methods are focused on specific technology platforms. Best practices, such as ITIL, recommend that organizations develop service-oriented accounting, which aligns all costs with a particular service, not with a technology platform.

When an IT resource, such as a server or staff person, is dedicated to a given service, it is clear where you should account for the cost. However, a major challenge is the allocation of shared resources, such as a virtualized server, by many different IT services. A common method for allocating the cost of a shared resource, such as a pool of shared servers shared by a set of applications, is to first group these shared costs and allocate them proportionally based on a the respective service's share. For example, you may decide to allocate a shared pool of staff members based on the percent of time dedicated to a specific service. Similarly, the cost of a shared pool of servers may be allocated to a number of services based on utilization rates of a given set of applications. Network costs may be allocated by the percentage of networking costs used by a given service.

To break down the technology silos and account for IT costs based on a service, the organization can develop a simple IT accounting form, such as the sample shown in Table 4-3 for a Web service. The sample organization has grouped the cost types by hardware, software, staff, facility, and depreciation and recorded these costs to a web-hosting service.

Table 4-3. Sample IT Accounting Form for Web Service

Apply a Consistent Method for Using Actual Costs, Averages, or Estimates

To gather expense information for a given service or activity, you can use three industry-accepted methods: estimates, averages, and actual IT expenditures. Actual expense data should be used whenever possible. However, within many organizations, exact data might not be available, usable, or might be cost prohibitive to collect relative to the benefits.

For example, if an organization has begun only to develop cost types and a basic accounting framework, it would be costly to collect retroactively the prior year's expenses and group them by service. Although sometimes necessary to use estimates, samples, or averages, you should try to use actual costs whenever possible. If you use estimates or averages, we also recommend you develop a plan or timeline to eventually capture actual costs:

• Estimates or samples: Based on a sample purchase order or industry averages, estimates are sometimes used to develop the cost of a specific service. A significant drawback of using estimated costs is that estimates are based on assumptions and do not reflect the true cost of service. As a result, estimates can create the risk of losses and inaccurate information being provided to customers when poorly applied. For example, if an organization prices its hosting services below its true costs, it might cause its business units to overuse these services. The IT organization will then lose money on each hosted server.
• Averages: Based on the average cost of a large sample of purchase orders, averages are sometimes used to develop the cost of a specific service. For example, an organization might estimate the cost of a UNIX server based on the average cost from multiple UNIX server invoices. These averages are more accurate than a single sample or industry estimate because they capture the information of your organization. Averages are less likely to understate of overstate the cost of a particular resource, as compared to an estimate or sample.
• Actual costs: Including actual costs is preferred whenever possible. The key to useful actual cost data is gathering IT expense information in a useful and agreed-upon format with your accounting or corporate finance department.

Table 4-4 summarizes how to develop a plan to improve your IT accounting information. Still if you cannot gather actual cost information, you can begin to better account for your IT costs using estimates or averages and tailor them to your environment.

Table 4-4. Developing a Plan to Improve Your IT Accounting Information

Improving an IT Accounting Process to Become the Profit Center or Business Partner

As an IT organization matures its financial practices to become a profit center or business partner, customers begin to view IT as a positive ROI or business partner. The organization's cost types are closely linked to operational information. IT financial processes reflect actual accounting data instead of estimates. Its costs/expenses are more closely tied with the organization's IT service catalog. The organization also identifies the value of IT, including its intangible benefits.

Improve Your Accounting Framework by Linking Costs to Your Service Portfolio

While throughout this book we advocate a service-based approach to financial management, an IT organization seeks to mature its IT financial management practices to a profit center or business partner, it must link its costs to its service portfolio. This practice helps you understand the cost structure of a specific service, referred to as the service provisioning value by ITIL, and provides a range of benefits. It enables an organization to benchmark against another IT service provider, support the creation of standard chargeback rates, and compare actual expenditures against a specific budget.

To implement this method requires that all IT expenses be either coded against a specific IT product or service or allocated across several specific IT products and services. For example, a shared application server may be applied to three different services whose applications reside within the server. An effective way to code expenses is based on the organization's IT service catalog, which includes a list of IT products and services provided by an IT organization, a description of each product and service, and a cost to purchase each product and service.

In the example in Figure 4-4, this sample organization has developed a process for aligning its costs to its services and organization.

Figure 4-4 IT accounting assigns expenses to specific services through cost types and classifications.

This detailed cost information helps an organization to improve service by developing accurate pricing for IT services by gathering increasingly detailed accounting information. This allows the organization's larger financial processes to integrate with the organization's processes for charging internal or external customers for IT products and services, and ultimately budgeting for new and ongoing IT expenditures.

Capture Actual Costs and Compare Against Your Budget to Prevent Cost Overruns

As your IT financial management processes improve, actual accounting data replaces industry averages and estimates. As noted previously, this actual data allows the accounting process to provide charging and budgeting processes with more accurate cost information. Using actual costs is often a significant change from the cost of service delivery currently used by the organization for ongoing IT financial management, chargebacks, and internal control functions.

For example, instead of average FTE estimates, the organization will use actual staff costs based on HR records and organizational charts. More accurate staff costs help identify hidden personnel costs. For example, while many staff include only those application developers or system administrators who work on a given service, they miss those administrative or other support staff whose costs must also be recovered. These actual costs can then be compared against a budgeted amount, thereby creating the ability to provide periodic (monthly, quarterly, and so on) financial reports to senior management and preventing cost overruns.

Improve Cost Type Links to Operational Information

As your IT financial management practices mature, IT cost types and service recording should be linked with the organization's inventory of IT assets. This inventory is often shared between the IT and financial organizations. In evolved IT financial management organizations, where its customers view IT as a business partner, the IT and financial organizations share a common set of information from a single database but just access different views. Table 4-5 summarizes some sample information you will gather for a server resource that links the server, software, application it supports, financial information, and the delivered and expected quality of service.⁷

Table 4-5. Example of Linking Financial and Server Information

As your organization's IT financial management matures, you may collect and link increasing amounts of operational information. For example, you may decide to collect additional data points on quality of service than those listed in Table 4-5. You may also want to collect similar information on networking, application development, and application maintenance.