These five financial metrics can be employed to optimize the business value of IT by tracking IT service delivery, IT efficiency, and business transformation.
You may find yourself juggling two dual roles: operate as a utility provider while also partnering with the business to drive innovation. While there is no one-size-fits-all approach to managing the business of IT, some key financial metrics can help you balance these two responsibilities.
Here we will explain five financial metrics that you can use to measure IT efficiency. We will also provide recommendations on how you can use these metrics effectively to manage the business of IT. To explore these financial metrics in more depth, you can download the full Executive Brief.
Unit costs are the direct costs on a per-unit basis for key components of your services. Common categories include:
Understanding and managing the costs of these components and subcomponents will allow you to get an accurate view of unit costs. Benchmarking your unit costs against other industry and your own business units will help you identify what needs further analysis and exploration.
» Solution: Apptio IT Benchmarking
The fixed to variable cost ratio helps you understand your cost structure relative to your strategy. For many companies, close to two-thirds of their IT budgets are taken up by fixed costs. Moving to a variable cost structure can give you the agility, flexibility, and scalability you need to meet changing demand.
A deeper understanding of your variable costs also allows you to perform variable cost dynamics. This analysis highlights how anticipated changes in your business will affect your total costs and budget demands.
Monitor your fixed-to-variable cost ratio and ensure it is in line with the needs of your business. Remember, lower is not always better. Organizations with economies of scale often find a higher proportion of fixed costs to be advantageous. Businesses that experience more significant organizational changes, especially reductions in staff, generally benefit from a higher proportion of variable costs. If adjustments are needed, work with procurement and/or finance to encourage the right types of purchase contracts.
Where are your costs primarily allocated? The answer to this question will help you determine your direct vs. indirect cost ratio. As with the fixed vs. variable cost ratio, the direct vs. indirect metric is difficult for most organizations to track due to limitations in their systems and processes. However, this metric, along with utilization metrics, can quickly identify opportunities for cost reduction. In particular, look for direct costs that are associated with poorly utilized resources.
Monitor your indirect-to-direct cost ratio. To improve this ratio, you should seek technologies, organizational changes, and business unit incentives to improve the adoption of shared resources.
OpEx immediately flows through your income statement. CapEx gets booked as an asset and flows through your income statement as depreciation over a period of time. CapEx includes not only hardware and software costs, but also the costs for deployment and development of these assets.
Many CIOs focus on raising their CapEx-to-OpEx ratio. This gives you an indicator of how much of your expense represents an investment for the business. But more important than OpEx-to-CapEx ratio is the IT CapEx-to-asset ratio. For CapEx requirements to address asset refresh needs, use a ratio that compares your annual CapEx budget with the purchase value of your assets that are fully depreciated or will be fully depreciated within the planning horizon.
For example, if you have fully depreciated servers with a combined purchase price of $10 million, and another $2 million in servers that will fully depreciate in the next fiscal year, your CapEx budget for server refresh should be based on $12 million.
There is no magical CapEx-to-asset value for IT. Many organizations will find a CapEx-to-asset value (as calculated above) of less than one adequate as the price/performance ratio of different technologies improves. While this metric provides a gross measure of capital adequacy, it should be combined with a more careful planning for asset refresh that considers measures that drive hardware refreshes. Capacity planning and business projects add to capital requirements and should be included separately.
Budgeting is generally an annual exercise, but forecasting should occur on at least a monthly basis. Forecasting is estimating how much you expect to spend in a given period or for the remainder of a project. Forecasted amounts are usually added to actual expenses to determine any variance that is expected from your budget.
Knowing your expected variances is vital for effective IT management. By identifying variances early, you can take prescriptive action. There are few things as detrimental to the CIO-to-business relationship than large, unexpected budget variances.
Armed in advance, you can also look for ways to offset any variances. You may be able to reduce expenditures in other areas, or in other quarterly periods, to make up for any shortfall. On the other hand, you may identify budget surpluses that allow you to invest more heavily in other projects that are important to the business.
Considering these five indicators will help you measure cost-effectiveness, an important factor in managing current and future costs. Which financial metrics are you using for measuring IT efficiency?