Tuesday, 23 August 2011 07:55

Business finance for the IT professional

If you are like me you espouse a view that a good IT department should not be seen as a cost to the business, and that it ought rightly be considered a strategic and operational division. Yet, at the end of the day it is all about numbers. The smart and forward-thinking IT leader will get a grip on the concepts that matter, and knowing these will help your own agenda.

I've written previously on the topic that good IT may well carry a price tag but at the end of the day it is not a cost to the business, but a benefit.

After all, if your company's IT department is not adding value, providing competitive advantages and enabling company employees to optimise their own job performance then what's the point? You should simply outsource an IT department which exists solely to 'keep the lights on'.

Now, you may be like me, in that you're a technical person and you've risen to the role of CIO or IT Manager and now find yourself spending more time on board reports than network analysis, more time on budgets than database tuning, more time on project planning than running your servers it's important you learn the lingo of the company executive.

This is similarly true for any other new manager who has come 'off the tools', so to speak, and gained their seat at the table via a combination of skill and experience and leadership rather than the alternate (and viable) route of a business or management background.

At the highest echelons a business boils down to numbers and the disciplined control of those numbers. Understanding these numbers and this jargon allows the IT leader to focus on them more easily, and to discuss them articulately and intelligently with superiors and colleagues alike.


The first thing you need to know is EBIT. This means simply 'Earnings Before Interest and Tax.'

EBIT is fundamentally the company's overall revenue minus operating expenses, excluding tax and income.

You might think this sounds like a no-brainer. After all, profit is revenue minus expenses, right? Well, yes, but the differentiating factor here is the 'before interest and tax'.


Consider the world of mergers and acquisitions. When purchasing a company you want to know how profitable it is. It doesn't take much imagination to recognise shrewd accountants can structure a business in way that masks various expenses and makes a business appear more profitable than it is.

In actuality, the purchase price of a business is often calculated as a multiple of EBIT and that's because it's a mutually agreed concept that eliminates variations caused by different capital structures and tax rates.

Consider EBIT like currency itself and how rather than bartering pigs and sheep, people around the world agreed to the use of legal tender as a standard for establishing value. Or, consider how the Simple Mail Transfer Protocol, or SMTP, permits different mail servers and clients on a wide range of operating systems to collaborate across the Internet. So too EBIT provides a standard for executives to compare the profitability of a business. EBIT gets to the heart of profit by nullifying the effects of different financial strategies.

Some take it further and work in EBITDA which also takes depreciation and amortisation out of the equation.
So why should you care about EBIT?

You should care because your boss cares. The CEO, the MD, the CFO, whoever you report to is obsessed by this figure.

Ultimately, the volume of sales is not a measure of company performance; it's EBIT. If your organisation does not have a healthy EBIT then it is in jeopardy. In all the strategies company management seeks to employ, the end goal of these is to maximise EBIT. Whether increasing revenue or decreasing costs, the plan is to bring this figure up, both as a percentage and as a dollar value.

You should care because your colleagues care. Branch managers and divisional heads across the company are similarly working on their EBIT. They will be assessed based on their EBIT. Their bonus structures, if they exist, will be based on it.
For the savvy IT leader, knowing this opens up a world of possibility to you. Knowing that EBIT matters and how it is calculated permits you to pepper your conversation appropriately.

Do you want to drive projects through the business but face difficulties in obtaining buy-in and adoption? Learn to speak the language of EBIT.

For example, you think that implementing a VoIP phone system will be a good idea? You may have many sound reasons but describing the wonderful features of presence awareness, consistent handsets across offices, extension-dialling and address-book lookups everywhere may result in merely a glazed torpor in the absence of a CEO or CFO who has a technical bent.


You need to ensure your arguments include impact on EBIT. What has the company spent on office to office landline calls? What has it spent on long-distance calls? Will these costs be eradicated by your proposal? If so, you can then intelligently articulate the VoIP proposal will have an effect on branch EBIT.

Every dollar not spent on the company's internal costs is a dollar directly added to EBIT. Your company cares about EBIT. If proposals coming out of IT visibly and positively impact EBIT the unmerited view of IT merely being a sinkhole for money can be shaken.

Profit and Loss

Hang around the company accountants for any length of time and you'll hear the term 'P and L' repeatedly mentioned.

This report, or statement, gives a breakup of a division, or company, gross revenues followed by a breakup of the broad categories of expenses, giving an overall net income figure which is ideally a positive number. If it's not, your company is spending more than it is bringing in.

The Profit and Loss statement reflects a period in time (for instance, August 2011). It helps management understand where their money comes from and where it goes.

The gross revenue is the sum of cash inflows, or other asset enhancements, received during a period for the activities that represent its major operations, be they the production or delivery of goods, the rendering of services or some other activity.

The expenses are, well, where the money goes. The categories listed here will correlate to General Ledger accounts and may include the cost of goods, wages, advertising, utilities and other items.

This report is used by management to identify problems, which again all relate back to maximising EBIT. In fact, there are two ways to increase EBIT, both of which relate directly to the information presented on the Profit and Loss statement.
First, you can hold your expenses constant but increase revenue. Secondly, you can hold your revenue constant but decrease expenses.

So, company management will look at this statement and figure if they reduced the amount they spent on, say, advertising then this will positively impact EBIT. Or, as we may commonly see, if they reduced the amount spent on computing and telephony expenses then this will positively impact EBIT.


You should care about Profit and Loss statements because of this information. How are your IT costs being allocated across the business? And again, can the projects you wish to implement visibly affect EBIT by having an impact on revenue or expenses?

Understanding this can help free IT leaders from focusing on their own expenses and looking at other areas of the business. Perhaps the development of an in-house software application will have a cost but ultimately free the company from a subscription-based service used that costs the company a dollar amount every time it is used. Management will not have problems accepting an increasing IT expense in their Profit and Loss statement if it means other line items decrease by a higher value.

Of course, I'm not advocating IT should be necessarily increasing its own spend, but there is many a berated IT manager who feels the endless pressure to slash IT expenditure. This is because your company does not believe, whether accurately or wrongly, that the IT expenses influence EBIT in any way other than that they are an expense.

The challenge to you is to understand EBIT, understand the Profit and Loss statement, and understand how your planned programs and projects will impact the numbers elsewhere, whether cutting IT costs, holding them constant or even increasing them. Ultimately the end goal is EBIT, no matter where it is derived from.


There is a lot more to business finance than the above two items, and I am sure your company accountant will willingly point this out. Yet, already, armed with an understanding of the above two concepts your understanding of what drives business intelligence will be greatly enhanced.

In turn, this leads to articulating your own programs in terms that management will love and grasp.

Let us finish with one other concept which is not a financial term nor exclusive to finance but which is a driver behind how costs are often allocated to the General Ledger accounts, and consequently make their way to the Profit and Loss statement, namely assumptions.

It is important to talk to talk to your company accountants about the assumptions they make regarding IT. Ultimately, they are allocating your expenses to various ledgers and categories as they understand it.

Yet, these assumptions may not always be correct based on limited understanding, or they may potentially jeopardise future plans.


To illustrate, chances are your accountants do not distinguish between the cost of Internet access and the private data network bridging sites and offices. To them, it is likely all 'Internet'. So, your company's Internet charge is likely to be viewed as tens of thousands of dollars per month if you have a sizeable operation.

Consequently, you'll find management coming to you and raising obtuse comments about a need to reduce Internet usage.

Suddenly, you may find talk of blocking websites, of restricting access, of preventing people downloading all sorts of things.
You may be surprised by these requests. You might even consider them draconian and merely reflecting a view of management to stop people engaging in non-work related activities online (which, in itself is a valid enough reason, although technical solutions alone are not the answer; management must also address the issue and not hide behind letting people discover access is blocked because of a message).

However, while there is a potential (some may say arguable) productivity gain to be had, the impact on the bottom line is going to be absolutely minimal. As such, it may not even occur to you that this is a driver in management making such requests. Or, if you do, you may question it to yourself because you know the actual Internet charges are not exorbitant to begin with.

Here is where you need to discuss what management hope to achieve and why, and then ensure that there is a realistic understanding of the IT costs. Take this back to your finance team or you will have the same discussion with every new manager who sees a big 'Internet' charge on their Profit and Loss statement.

What other assumptions are being made about the ethereal and arcane IT costs? It would be worth your time making an appointment with your company's financial officers to discuss this and help re-allocate your costs appropriately.

Let us return to the example above of in-house development, too. Consider that your company pays for a subscription service with either a recurring monthly fee or a fee-per-use. You see this and recognise that the service can be provided equally as well, or better, via an in-house application. You make a coherent argument - because you express it in terms of maximising EBIT - and this gets approval to proceed.

You then spend a month developing this, whether through resources already at your disposal or engaging contractors. Either way, it gets done.

Now, your CFO sees this and then decides for this month your salary should be allocated towards development costs, not the actual company's product costs as it usually is.


Yet, this is a risky strategy for both you and for the business. The problem here is that management will later see a high-level overview of company's expenditure and make two invalid conclusions.

First, they may decide development costs are too high and eliminate future development projects.

Secondly, they may see production costs as lower than they are and make forecasts and projections based on this.

Of course, in reality, one person's salary for one month is unlikely to make a sizeable impact on decisions like these but add enough assumptions together and you can see how information is able to be misused and misunderstood.

As much of a techy as you may be, the reality is the CIO and IT Manager must live in a world of numbers - not CPU cores, bandwidth and disk space - but EBIT, Profit and Loss and the assumptions leading to the allocation of expenses.

While there is so much more, master these three concepts and you will understand the business so much better, you will have more success in obtaining buy-in for your projects, and you will control how the business perceives the value they get from IT and where their money goes.


Be sure to check out previous installments of The Wired CIO here on iTWire.

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David M Williams

David has been computing since 1984 where he instantly gravitated to the family Commodore 64. He completed a Bachelor of Computer Science degree from 1990 to 1992, commencing full-time employment as a systems analyst at the end of that year. David subsequently worked as a UNIX Systems Manager, Asia-Pacific technical specialist for an international software company, Business Analyst, IT Manager, and other roles. David has been the Chief Information Officer for national public companies since 2007, delivering IT knowledge and business acumen, seeking to transform the industries within which he works. David is also involved in the user group community, the Australian Computer Society technical advisory boards, and education.

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