There is a need to develop an IT finance management framework and I propose a general framework for a specific organization as a starting point.
Some of you may be wondering why EA & IT strategy person proclaims a need for development of a general IT finance management framework and proposes one for a specific organization type.
To develop practical enterprise architecture and receive value from it, understanding the financial management and integrating to the enterprise architecture is a key. IT Finance management plays a vital role in enterprise architecture analysis. For instance, to identify and report the cost drivers for systems with high maintenance cost in the enterprise, enterprise architects required to generate the list of software systems which has high maintenance cost first. If the enterprise system landscape is not integrated with the IT fiancé management, this of kind of analysis becomes manual, laborious and inaccurate.
Current state of IT Finance Management:
IT Finance management function is performed in non-uniform way across the industry. Lack of a general framework in IT Finance Management leads the IT industry to proliferate inconsistent methodology and creates a challenge to collaborate and share knowledge.
For broader utilization of the framework, the framework development needs collaboration and participation from IT financial analyst across multiple industries. As a starting point, I’m going to propose a general framework to manage IT finance for a specific organization type and welcome critiques from others to improve it.
Organization Type:
The proposed framework is for IT organizations which are business enablers, does not directly generate revenue, does not pay cash directly to payables and perform three major functions.
- Lights on support to IT systems to enable business
- Perform Enhancement/Discretionary changes to meet business requirements
- Execute projects to transform/thrive/sustain the business
Key steps in IT Finance Management:
- IT Financial Planning
- IT Budgeting
- IT Finance Reporting
IT Financial Planning: It is a first step in the ITFM. Financial planning must be aligned to corporate strategy. Corporate strategy provides a road map to reach corporation’s vision and corporate annual plan is a step towards reaching the organization vision. Annual corporate plan is an execution step of corporate strategy. Based on annual corporate plan, IT financial plan is developed by the IT Financial analyst, office of CIO in collaboration with financial controllers (Office of CFO) and office of Chief operating officers. The decisions like, invest in more product development, penetration to a new market segment, expand the presence to new country and etc are made, part of the annual corporate plan. IT financial plan is a high level executive plan to support the annual corporate plan. It will consists of major line items like, improve IT spend on new security projects, change systems to support multiple languages, continue the same level of lights on operation , improve the system reliability and etc. IT Financial plan will be created and will be used as base line to develop the IT budget.
IT Budget: Budgeting is a one of key piece of IT Finance management. Budgeting is a development of IT organization cost plan for the year. Cost plan answers questions like, What is the total cost IT organization can spend and how they are going to spend. Once the budget is approved by CIO and corporate controlling, then the actual cost are tracked on monthly basis and variance analysis are preformed and reported to the various stakeholders like CIO, controlling office, senior management team, managers and others.
There are three different types of budget for different purposes.
- Capital Budget – Lays out a plan for investment like plant installation, product development and provides a principle for investment life cycle steps like depreciation, amortization. Generally it is managed by a generalized group for the entire company. It is one of the functions under controlling organization under the CFO.
- Cash Budget – It is a predication of expected cash balances the organization will experience during the forecast period. Cash budget depends on operating and capital budget. It also evaluates if the corporation has sufficient liquidity (like cash in hand, credit) available to meet the expected cash disbursements. It is part of the management accounting. The cash flow and fund flow of the corporation depends on the cash budget.
- Operating Budget – It is a plan to reflect the daily operating expenses and depreciation. Typically the operating budget is developed annually.
For the organization selected, IT budget will be an operating budget. The major functions performed by the organization are lights on, enhancement and projects. It is so tempting to categorize all the cost under these categories in the highest level. It will become difficult to analyze different perspective of the IT cost structure like by hardware, provider etc.
Cost Categorization:
- Employee – (On roll employees)
- Contractors – (includes purchased service, consultants and etc)
- Sourcing Providers – (in source, out source, multi source and etc for a specific service)
- Software recurring fee – (includes software maintenance fee, service fee and etc)
- Hardware recurring fee – (includes all servers, mainframe, disks, network, hardware maintenance fee and etc)
- Others – (It is a catch all category includes like travel, training, depreciation, office & admin, rent, telephone, stationary, depreciation, rent)
The categorization is not a clean separation. As needed, the items in each category can be shifted between the category.
Direct cost vs indirect cost, project cost vs lights on cost are various categorization of cost structure. Those cost categorization are just allocation issue. Once the cost are captured in the above categories, then the various other perspective can be easily created. I will demonstrate it specifically how to capture and how to report it.
Any line item in general & administration (G&A) spend in the IT organization should come under in one of the above category. This does not include the capital budget. Any capital project under taking or any new capital software purchase will not be included under IT G&A budget. That will come under capital budget. The scope of the framework at this point is to focus on G&A only. Once the framework is matured for G&A, capital budget can be added at the later stage. However, the capital budget will feed the depreciation value to the G&A.
Let us say the IT organization has the budget of $100. CIO has 4 directors reporting to him and there is a small set of staff in the office of CIO who directly support the CIO in the strategy, architecture, IT financement and etc. Let me show the end result of the budget and walk through the steps involved in the framework. After the budget cycles are complete the budget of IT organization of $100 will look like as given in the figure.
Let me walk through in part #2 what technique should be followed and each and every steps to develop an IT budget for the $100.
