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Handout #9 – financial management

Financial Management Framework

A solid financial framework establishes the rights and responsibilities of business and IT management in making financial
decisions. Investments in IT as well as normal operations require decision on significant financial transactions on a regular
basis.

IT Investment Committee – composed of representatives from the business functions and the various IT disciplines
– is a good control mechanism for ensuring that decisions on IT investments (technology and
business projects) comply with organizational priorities and technology standards.

To be effective, the IT Investment Committee must have authority to make decisions on behalf of the board and senior
management. Although overall funding decisions are made during the financial planning process, the IT Investment
Committee would approve individual capital purchases and projects.

Investment Approval Process

The cost of developing new applications or implementing new technology is costly and consumes significant resources. It
is important therefore to make sure that the application to be made fits within the enterprise architecture and aligns to
business objectives. An investment approval process helps ensure that efforts are aligned with organizational objectives
and enterprise architecture, and the business case is realistic.

An investment approval request should include six major components:

1. Business need
2. Financial return and contingencies
3. Alternatives considered
4. Business issues and assumptions
5. Legal, legislative, environment, safety issues
6. Resources required and proposed technology

Project Pricing

Project pricing provides user groups with the total cost implications of a project. Project cost estimates should include the
total development costs and infrastructure costs to allow management to understand the impact on the operating budget
and make an informed decision.

Realizing the Benefits from IT Investments

Projects are usually done to add business value by growing revenue or reducing expense. It is important to verify that the
benefits expected are delivered. Project benefits should be stated in measurable terms during the project approval phase
to provide a means for validating the benefits received. Each project should have an owner with accountability for delivering
the benefits.

Financial planning

Financial planning and controlling processes are key processes in managing the investment in IT.

Financial planning in IT begins with an understanding of the annual business plans, including business volume growth
projections and new technology investments.

Two possible approaches to developing a financial plan:

1. Top-down approach – involves setting spending targets based on an organization’s overall financial plans and then
building a detailed budget for each service to fit within the overall targets set by the organization.
2. Bottom-up approach – IT will have a spending target amount of either a percentage of revenue or a fixed amount.

Operating Budget

1. Determine estimated growth based on normal historical trends and additional/reduced demand from business plans.
2. Service Planning – involves developing a budget for each of the services based on the expected demand, cost
increases, and savings for each service; Project planning – involves working with user groups to ensure alignment
with business strategic planning.
3. Once the budget is completed, it needs to be reviewed and approved by the group responsible for funding.

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Capital Budget

The capital budget defines the cash needs and expense impact over a period of time. If you remember, in your financial
accounting 1 (Acctg 5&6), businesses capitalize developed software and amortize the expense over a period of time (PAS
38, Intangible Assets; SIC 32, Website Costs) if a technical feasibility has been established. Otherwise, the costs shall be
charged to expense. Website costs developed for the purpose of promoting and advertising products and services are
always expensed when incurred.

Track against Budget

Throughout the year, it is important to track actual to planned results. There are two possible variances:

1. Volume – caused by an increase or decrease in demand; attributable to user activity


2. Rate – caused by an increase or decrease in costs; attributable to IT management

Developing a Pricing Model

NO CHARGEBACK In this model, the IT budget is a separate function approved


as part of the organization’s planning process. To be
effective, the organization must have a centralized
prioritization and approval process to control IT spending.
This is a low-cost alternative, which also provides a
centralized approach to funding for the good of the
enterprise. Disadvantages include no accountability for
demand and users do not necessarily understand the cost
of the IT resources they are consuming.
NON-IT BASED CHARGEBACK In this model, IT costs are allocated to business units based
on a non-IT allocation metric (for example, % of revenue).
Disadvantages are that cost allocations do not necessarily
correlate to the cost of the service and
consumption/demand cannot be allocated to the business
unit using the service.
IT-BASED CHARGEBACK This approach uses IT measurements to allocate costs to
user groups. This model aligns consumption with costs, but
IT measurements are difficult and costly to implement; and
can be difficult for users to understand and relate to
business activities.
DIRECT CHARGEBACK This approach allocates specific costs for an entire service
to a business unit.
FEE-BASED CHARGEBACK This approach charges a negotiated fixed fee for a specified
level of demand/service. This model can work well with a
homogenous service such as charge per PC.
BUSINESS-BASED CHARGEBACK This model allocates costs based on a business
transaction.
PROFIT-ORIENTED PRICING This model charges a fee for service similar to an external
service provider. Depending on the organization and tax
rules, profit can be added to standard pricing to fund
internal IT projects.

The key principle for pricing IT services is: the model used to allocate costs must be “arm’s length”, meaning the prices
charged must be comparable to what independent service providers would charge in the same circumstances.

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