One thing that you’re likely to encounter in any IT department is resentment toward the Finance department. A staffer might be angry because “those bean counters in Finance who know nothing about technology” directed him to buy one product when he wanted to buy a different one. Or maybe Finance approves the acquisition of an application, but it says to get the server version, not the cloud version (or vice versa; Finance’s decisions can seem maddeningly unpredictable). Or it outright rejects a request to replace a system that users consider to be a boat anchor. “Why?” asks IT. Because, says Finance, that boat anchor can’t be replaced until it’s fully depreciated — never mind that that will be several years in the future.
Without a grounding in your organization’s capital structure and financial practices, such decisions can make Finance appear arbitrary — a description that would amaze most people in Finance, who think of themselves as methodical, pretty much the opposite of arbitrary. In most cases, Finance has practical reasons for its decisions, but to IT leaders, they can seem to defy logic because they are completely unrelated to IT concerns.
If you want to be an effective IT leader, one whose funding requests are usually approved by Finance, you need to take the time to understand your enterprise’s accounting practices. Here are some of the things that tend to drive Finance’s decisions but can seem rather opaque to IT leaders who don’t bother to study their company’s accounting practices:
- An aversion to balance sheet write-offs. Most Finance departments will capitalize major systems or other investments so that the cost is spread over several years. Finance wants to please the stock market, which likes predictable earnings, so minimizing charges to earnings in any one year is, for them, a no-brainer.
Once an asset is on the balance sheet, accountants and management really dislike writing it off early because write-offs are viewed as failures by the stock market. That’s why Finance may make it difficult to shut down a failing program or to replace a system that is not yet fully depreciated. Letting depreciations run their full course is such an engrained part of the Finance mindset that it takes a very strong political coalition and a highly compelling business case to shake it.
- A commitment to strengthen the balance sheet. For Finance people, a weak balance sheet means they are failing the company. Startups and other companies with weak balance sheets have difficulty borrowing money, and paying bills as they come due can be a struggle. Any company in that situation wants to conserve cash as much as possible. That puts most capital expenditures out of the question — Finance will almost always want to rent, even when the total cost of ownership favors buying. That might be why your Finance Department prefers cloud, with its low initial cost, over the higher upfront cost of a server and software.
- The company is EBITDA-driven. Private equity firms often use EBITDA (earnings before interest, taxes, depreciation and amortization) as a way to justify the sale price of a very fast-growing company. Devised in the mid 1980s by leveraged buyout firms, EBITDA was used to measure a company’s ability to service its debt after financial restructuring. Today, a number of startups and other companies with unconventional balance sheets use it, even though it is not consistent with Generally Acceptable Accounting Principles or International Financial Reporting Standards. An EBITDA-driven company is one whose Finance department will be more likely to tell IT to get the server-based version of an application rather than the cloud version.
If your company uses EBITDA, take advantage of it. Structure projects to be capitalized and to have minimal operating expenses. Some companies go to extraordinary lengths to transform monthly operating costs into capital expenses. One creative company engaged a second-tier cloud provider and required it to use dedicated servers that the company purchased (along with perpetual software licenses augmented with multiyear support). This added operational complexity to the cloud provider, which had to operate the customer’s equipment separately. However, the monthly charges from the cloud provider were lower than they would have been if the cloud provider owned the servers and software licenses. When the buyer capitalizes servers and licenses, monthly operating costs under EBITDA are lowered, since depreciation is not included.
- The company is in bankruptcy. Companies operating in bankruptcy have to get permission from the presiding judge for any expenditure beyond normal operating costs. Bankruptcy is designed to be a short-term, temporary state until the company can work through its problems. As a result, most judges are reluctant to allow any new expenditure without a very short-term payback. Even if a new system would significantly improve longer-term operations, it can be difficult to justify.
If you believe it is important to make an investment that does not have a very quick payback, be prepared to convince the judge that without the new investment, the value of the company will be lowered significantly within one or two years.
- The company is financially stable. Profitable companies with strong balance sheets have the financial flexibility to analyze each situation separately and determine the approach that provides the best return to shareholders. Mature organizations normally have more bureaucracy and controls, because their financial analysis processes are designed to analyze all rent-or-buy options completely. These processes are usually logical and well designed, unless they have grown organically over time and have not been examined for years.
Unfortunately, many Finance groups do a poor job of educating the rest of the organization about capital structures and the rationale for accounting practices. If you don’t understand, ask Finance to explain them. You may not like the apparent control that Finance can have on IT architecture or package selection, but it is a business reality. It’s important to realize that the Finance group is just doing its job and is not picking on IT. Every department will face the same restrictions when they want to invest in new capabilities.
When you are unhappy with Finance-imposed constraints, it is usually difficult to get the decision changed without a very good reason. But if you are truly convinced that financial restrictions are creating a bad decision, prepare a very compelling argument, build a strong political coalition and get ready for an extremely long discussion. Most of the time, it’s not worth the effort, and you may still lose in the end.
Don’t tilt at windmills. It’s exhausting. Save time, effort and frustration by learning how to work within your enterprise’s financial constraints.
Bart Perkins is managing partner at Louisville, Ky.-based Leverage Partners Inc., which helps organizations invest well in IT. Contact him at BartPerkins@LeveragePartners.com.
