The need to control IT cost more effectively has underlined the financial management component of the CIO’s job. Now is a good time, therefore, to brush up on some of the basics of finance.
According to Michael Blackstaff, consultant and author of Finance for IT Decision Makers, there are some important financial concepts that often elude IT professionals.
One of the most important of these is the distinction between profit and cash, he says. The difference is that profit, unlike cash, is affected by the depreciation of assets. In IT projects, which typically involve buying hardware and software, depreciation has a significant effect.
“When thinking about investing money in an IT project,” Blackstaff explains, “there are two ways you can look at it: what is the likely effect of this project on our cash flow, i.e. how much better off are we going to be in five years’ time in terms of cash generated; or how much extra profit are we going to make as a result of this project?”
The most common tool for evaluating IT projects is return on investment (ROI). What IT professionals often fail to understand is that ROI is based on profit, not cash, and therefore the depreciation of assets must be included in the calculations.
Another common misconception, Blackstaff says, is that the cost savings delivered by a given system affect the bottom line every year that system is in place.
“Let us suppose that a stock control system is being proposed that will allow the company to reduce its stockholding by £1 million-worth of stock,” he explains. “There is a great temptation on the part of someone putting together the business case for this system to claim that £1 million as a benefit in all the years covered by the evaluation. But in fact, the only benefit that is attributable to the system is a £1 million reduction in year one.”
Errors such as these can be especially dangerous in small organisations, where the head of IT may be petitioning the board for investment directly. But even in larger organisations where trained finance professionals are available, he says, it pays for IT leaders to understand the true financial impact of their investments.
“IT business cases are not an everyday occurrence for all finance people, so they could contain errors that even financial people might not pick up,” he says. “And the last thing they want to do is go through line by line a business case from an IT person that has delivered in the past.”