Metric Monday: CapEx Ratios

A look at one of the key financial metrics that can help IT departments balance their responsibility to operate as a utility provider with the pressure to drive innovation—to better manage the business of IT.

Metric: CapEx Ratios

Operating expenditure (OpEx) immediately flows through your income statement. Capital expenditure (CapEx) gets capitalized, or booked as an asset, and flows through your income statement as depreciation over a period of time. CapEx not only includes hardware and software, but also the costs to deploy them and certain application development costs. The accounting rules governing the capitalization of costs are complex and vary from company to company, but every CIO and IT executive should understand how the rules apply to them.

»See also: “These 7 finance principles are essential for IT cost center owners”

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. Since these investments create useful assets, a higher ratio means you are investing more of your money in long-term value. However, a higher ratio also contributes to a higher fixed cost structure, as fixed asset depreciation is a fixed cost. Regardless, there is no magic number for the right level of investment; it depends on your business.

The IT CapEx- to-asset ratio is even more important. For CapEx requirements to address asset refresh needs, we recommend using a ratio that compares your annual CapEx budget with the purchase value (original value at time of creation) of your assets that are fully depreciated or will be fully depreciated within the planning horizon. This ratio is crucial to maintaining the long-term cost effectiveness of your IT organization.

Recommendations

There is no magical CapEx-to-asset value for IT. Many organizations will find a CapEx-to-asset value 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.

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