5 Considerations when Developing the IT Budget

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Almost every type of organization struggles with effective information technology (IT) budgeting. Often there is a disconnect between the IT team and the finance department; the IT team doesn’t understand the organization’s budgeting process and the finance department doesn’t understand IT. Leaders can remedy this disconnect by changing the organization’s approach to IT budgeting and move it from an annual “make it fit” endeavor into a much more meaningful ongoing planning process.

This culture change requires more than just throwing numbers into a spreadsheet. Leadership has to work together to define IT’s role in achieving the organization’s objectives, and transform IT from a cost center into an investment.

#1 – Effective IT Budgeting is Like Effective Financial Planning

Personal financial planners must consider each client’s short and long-term goals; considering not only current constraints but also future goals and objectives. A similar concern with constraints applies to IT budgeting. What is the organization’s cash flow? How will IT spending impact the organizations capital and operating budgets? Are there major projects that must be addressed that might impact the IT infrastructure?

The human element also is one of the key, and most often overlooked, aspects of IT initiatives. Is the organization making other changes that might impact its employees’ ability to absorb a new computer system or other IT investment? How would an IT initiative affect employees’ work lives?

Good personal financial planners help clients look at various investment options and savings strategies to determine what makes the most sense based on each client’s life stage, risk tolerance and savings ability. Financial planners discuss multiple investment and savings scenarios with clients to determine what best meets their short and long-term needs. From this process comes the final financial plan.

IT and Finance leaders should develop their organization’s IT budget in much the same way. They should use multiple versions of the IT budget to analyze technology options and their associated financing strategies. They should look at each IT initiative as an investment option, the timing and execution of which affects the overall IT budget. They should consider different timing or initiative phasing to identify how different execution scenarios might impact the organization’s IT budget and cash flow.

#2 Align the IT Budget with the Organization’s Strategy

The next step is to validate IT’s role in the organization. The IT budget often is treated as just one big mass; however, it really has three distinct components. Those components are:

Run: These budget items keep the organization operating. Examples of Run budget items include mission-critical server replacements, key software upgrades, and personnel costs associated with administration and connectivity. Organizations that have to trim IT budgets should avoid cutting Run initiatives. Such cuts could introduce operational risks, and if an organization is already going through a tough stretch, the last thing it needs is a server, application or network failure.

Grow: These budget items help the organization introduce new capabilities or improve existing ones. Grow initiatives could include the implementation of new software that makes operations more efficient, the purchase of a new firewall that provides additional protection from cyber threats or an upgrade of the organization’s website that improves interactivity with customers. Grow budget items should tie directly to the organization’s strategic initiatives. Grow initiatives usually are not as mission critical as Run initiatives and often have some time flexibility, which means that they are good candidates for starting early when additional cash is available, or for deferral if cash is tight.

Transform: These budget items are more innovation, research and develop focused activities. These initiatives might seek to identify, for example, the right technologies for new organizational capabilities, fundamental changes to business processes, or a new product or service offering. Examples of Transform initiatives include proof of concepts, prototypes and small-scale testing of new systems or business applications. When finances are tight, transform initiatives often are the first to be cut or deferred—unless they are associated with key strategic initiatives that the organization views as essential to its continued operation. Even if the organization doesn’t deem certain Transform initiatives immediately essential, care should be taken when considering cutting or deferring them. That’s because Transform initiatives often are key to the organization’s long-term health. Failure to provide adequate resources to Transform initiatives can stunt an organization’s future success.

Organizing budget initiatives into these three categories can help non-technical leaders and boards identify the priority of IT spending and correlate the value that IT is providing to support the overarching goals and objectives of the organization.

#3 Assess the Financial Impacts of the Budget

The finance department can help determine whether the IT budget makes financial sense or not. In making that determination, the following considerations are key: (1) impact on financial key performance indicators (KPIs); (2) impact on financial statements; and (3) impact on cash flow. Because IT budgets often have large capital and operating expenditure components, the final IT budget needs to be incorporated into the organization’s overall budget to determine whether the timing or financing options for IT initiatives could have any unintended consequences.

Loan covenants, leasing agreements, contracts and grants, and other arrangements also may have certain financial requirements or metrics that should be considered when developing the IT budget. Sometimes, adjustments to the timing of initiatives or different financing arrangements for the initiatives can help to ensure that an organization meets both its compliance requirements and internal KPI measurements.

Finally, and most importantly for smaller organizations and not-for-profits, finance professionals must consider the impact on cash flow. IT initiatives often have large upfront expenditures for purchase and implementation. Organizations can manage the impact of these initiatives on their cash flow by, again, adjusting the timing of the initiatives (or purchases within the initiative) or by obtaining different financing arrangements.

One way to manage cash flow is to use a reserve approach to IT budgeting. Similar to the way reserve requirements are computed for a homeowners’ association, an organization can plan to set aside cash each year to ensure that it has the funds necessary to execute future IT initiatives. This process also helps reduce the risk that an unexpected technology failure and early replacement would have a negative impact on the organization’s cash flow.

#4 Expense Types and Categories

Sometimes, IT budgets are treated as a big bucket. To support better decision making and planning, the IT budget should identify expenditures by type and category. In addition to the standard personnel and non-personnel expenditures associated with other functions, the IT budget should identify the following IT-specific expenditures:

Staffing & Services: This encompasses any human element of providing IT leadership, governance, support or administration. Consider line items in your general ledger for salaries, wages, benefits, taxes, and any potential outsourced people services.

Connectivity: This encompasses any fees that your organization may have for telecommunications. It will likely include internet service provider fees, but may also have things like phone lines, PRI’s, SIP connection, MPLS, or even mobile phones.

Software: This would encompass any software related fees. This could be for Software-As-A-Service applications (such as Office365, or even enterprise applications), software renewals (like software assurance, or Anti-Virus software subscriptions), or even new software purchases that may potentially be part of the capital or operating budget.

Hardware: This encompasses the infrastructure equipment like servers, workstations, switches, access points or firewalls. Be sure to budget for any fees beyond the cost of the equipment including installation costs, maintenance contracts, warranties, etc… Many of these hardware infrastructure components will be capitalized and depreciated over time, but more innovative models allow organizations to lease these under an operating lease.

Training: Be sure to allocate some funds in the operating budget to ongoing training. This can be through formal training programs or could be subscriptions to industry learning. Technology changes so fast and it is important to ensure that your organization stays on the forefront of technology.

IT budgets should also address three main categories of IT spending:

Capital: These expenditures need to be considered as part of the organization’s capital budget; usually, this means that the spending will need to be capitalized. These expenditures include purchases of hardware and large software licenses, significant repairs, parts replacements and major software upgrades. IT expenses can consume a significant portion of an organization’s capital expenses (25-50%).

Operating: These expenditures are related to operations and usually include subscriptions, maintenance and support for hardware and software. Depending on your specific industry, operating budget may constitute 2% – 10% of the operating budget.

Projects: Usually, project expenditures are tied to a discrete effort. These may or may not need to be capitalized and may be required or discretionary. Project expenditures often are a flexible part of the IT budget; they usually can be accelerated or pushed back depending on cash flow or other events.

Identifying the categories of expenditures helps to break the IT budget bucket into identifiable components that can be used to support organizational planning and cost management.

#5 Organizational Status Considerations

Not-for-profit, academic, government and healthcare organizations have an additional variable to consider when looking at IT initiatives and it has everything to do with their status.

Not only do many hardware and software vendors make their products available to these organizations with specialty statuses at discounted rates, many services organizations have special rates tailored to these industries. Be sure to check with your suppliers and partners to ensure that you’re leveraging potential discounts if your organization fits in one of these categories.

Additionally, for non-profit organizations; there are grant opportunities available to fund aspects of IT. Many grants fund one-time capital expenditures but not ongoing operational expenditures. Not-for-profit organizations also must consider funding sources and grant opportunities when structuring IT budgets to ensure that proper funding is provided for both the capital and operating portions of all projects. Often, not-for-profits jump to take advantage of a grant opportunity but forget to assess the impact on their operational budget.