Monday, August 23, 2010

You Don't Understand Your IT Costs

Do you know what your IT costs are? I hear many technology Directors now saying, absolutely! They will rattle off their IT CAPEX budget for the current year and perhaps the last two or three years. They probably have a line item view of the IT P&L with a deeper view into some areas such as maintenance contracts, consulting expense and supplies. For the majority of technology directors however who came up through the ranks of network engineering, data base administration or something equivalent, that is where the understanding ends. Many do not understand how CAPEX ultimately ends up on their P&L (through depreciation) and will struggle when asked to classify their total IT spending into categories such as business application expense versus collaboration application expense. Ultimately however being able to classify your total IT spending into categories that you can then easily use to bench mark your spending levels against industry standards is fundamentally what is meant by “understanding” your IT spend. Below are three practical tips that can be used by Directors just trying to get a handle on overall IT spend or by new comers trying to truly understand how his or her new IT operation functions.

Know Your Asset Classes

Every company will categorize capital spending into classes. These classes are used by accounting for grouping specific assets together for depreciation purposes. For example, IT may have the asset classes “PC's”, “Servers” and “Software”. The depreciation on your P&L is the sum of the depreciation from each of these asset classes. The more detailed your asset classes the better, this will enable you to answer more specific questions about how your IT OPEX breaks down. For example, the total amount of your IT OPEX dedicated to PC's for 2009 may be equal to the amount of your total maintenance contracts dedicated to PC hardware & software PLUS the amount of depreciation carried on your P&L that is directly attributable to PC purchases. To know the amount of depreciation directly attributable to PC purchases you must of course have an asset class specific to PC's. So, go to your accounting department and ask for an IT depreciation report by asset class. See if you get the level of detail you need to make sense of the depreciation on your P&L, if not talk to your accounting manager and ask about creating IT asset classes that match your desired categorization strategy.

Know Your Maintenance Costs

Anyone who has had responsibility for managing maintenance contracts within a medium to large IT operations knows what a challenge this can be. You may literally have hundreds of hardware & software contracts all with different renewal dates. Very large IT operations may have a dedicated person and a sophisticated IT management software package dedicated to keeping track of maintenance contracts. In the typical medium IT operations, this duty is loaded onto the technology director who is generally armed with a self created spreadsheet for tracking. Here are some tips. First, get a feel for what contracts you have that are “pre-paid” expenses and which ones get expensed in the period they are due. Usually larger contracts (read Microsoft or SAP) get amortized over the course of a year so from an accounting perspective they effect net income evenly across the year. The cash is of course paid when the invoice comes but the “expense” for these contracts is spread evenly across your P&L throughout the year. This is important from a budgeting standpoint, you should create a list of your “pre-paid” maintenance contracts and have accounting start the amortization of these amounts on the first day of your fiscal year. You should classify these expenses on your tracking sheet into categories that match your asset classes. Once you have a depreciation report by asset class along with a detailed view of your large maintenance contracts both categorized into your desired OPEX classifications, you are well on your way to being able to categorize your total IT yearly OPEX. You cant forget your smaller maintenance contracts that simply expensed as they are received. In aggregate, these can add up to be significant so you need to capture them in detail on your maintenance contract tracking sheet. Ask your accounting manager for a report detailing the line items that made up the maintenance contracts on your IT P&L. Generally, maintenance line items listed as “accruals” will be the “chunks” of the larger maintenance contracts being spread evenly throughout the year. There should be detailed enough description on all other line items for you to ascertain what the expense was for (e.g. web filtering software etc.). Classify these contracts into your desired categories as well and you should have a firm grasp on your yearly IT maintenance contract commitment.

Understand your IT GL Codes

General Ledger (GL) codes are used by your accounting department to classify expenses into line items that will be shown on your IT P&L. For example, if you look at your P&L and see a line item called Wide Area Network, chances are your company has an IT GL code labeled Wide Area Network. As bills come in from your WAN carrier, they are “coded” to this GL account. It is important that you have IT GL codes at an appropriate level of detail that will allow you to easily classify your P&L costs into your desired IT OPEX categories. For example, if one of your desired categories for tracking IT OPEX expense is “Customer Support Operations”, it would be ideal to have a GL code labeled that and have all expenses related to that activity coded to that GL account. Avoid GL codes like “miscellaneous”, these create black holes into which IT expenses disperser, never to be understood again. Certain GL codes may be dictated by the need for your organization to report expenses in certain ways for regulatory or tax purposes. This means you will likely never see your IT P&L arranged totally into the categories your desire. For example, you will likely always have GL codes for “Salaries”, “Benefits”, etc.. So you will always have some leg work to do to completely organize your P&L into your desired OPEX tracking categories but with a set of IT GL accounts that match your goals as close as possible, your job will be much easier.

With these three steps you will be well on way to having a full understanding of your IT OPEX. Having this understanding and being able to classify your IT expenses into categories that can then be used to benchmark your IT operations against industry norms will gain you huge credibility among your management team and will give you a clear set of goals to manage towards.


  1. I would be interested in knowing if you get into deeper detail of activity-based costing of your IT operations. Costs to run certain applications, how you make transparent cost of running Application X is more expensive than Application Y and if off-loading select applications to the cloud could be less expensive. Any charge-back to depts ??
    Matthew @ SAS

  2. Hi Mathew. I dont do any ABC for my IT costs at this time. No charge back either although I am at the point where Ican start doing some degree of "show back", hopefully a good first step. I am in the process of coming up with a model to compare the cost of cloud hosting to in house running of specific applications. Once I get something worked up I will share it. Thanks.