What not to love about cloud computing? It enables businesses to efficiently and effectively use shared hardware, software and other services as needed. The cloud model typically shifts the responsibility for ownership, maintenance and operation of IT services from an internal IT organization to an external provider. Just ask any software, infrastructure or platform as a service provider for the benefits. They can tap them from memory as the promise of Allegiance: efficient scalability, high availability, greater operational agility, disaster recovery, workforce mobility, increased security, reduced capital expenditure, and the list goes on. That sounds like good news for any CIO whose plate is overflowing with ‘wake up in a cold sweat’ challenges in all these areas. Where do I sign, right?
“NOT SO FAST!” SAY CFO
Companies considering switching to cloud computing need to fully understand that the decision could potentially impact the key firm’s financial metrics, including EBITDA. What is EBITDA? EBITDA is defined by Wikipedia as: A company’s earnings before interest, taxes, depreciation and amortization. EBITDA is an accounting measure calculated using a company’s net income before deducting interest expense, taxes, depreciation and amortization as a measure of a company’s current operating profit.
Why should a CIO be concerned about EBITDA? EBITDA is widely used in many areas of finance when assessing the company’s performance and valuation. In many cases, EBITDA is also a key metric used to determine an executive’s incentive bonus, including the CIO. Now do I have your attention?
If a company does not use cloud computing and decides to buy hardware, software and other technology infrastructure, the expense is reported financially as a capital expense and the asset is amortized over time. In essence, capital expenditures do not adversely affect EBITDA. However, cloud computing fees are recorded as an operating expense. Services recorded as an operating expense may adversely affect EBITDA because this measurement is adjusted for depreciation of capital expenditures but not for operating expenses.
Investing in cloud computing can bring many benefits to the business, including reducing overall IT spend. However, because cloud computing expenses are treated as operating expenses, they negatively impact EBITDA, and possibly you and your boss’s compensation. Conversely, it will cost more to buy hardware and software in a business model, but it has no negative impact on EBITDA.
WHAT SHOULD A CIO DO?
First, the most important thing is that the CIO, CFO, CEO and other policy makers discuss and understand Cloud Computing – the EBITDA Paradox. Because the financial implications for the business can be significant, it is imperative that the executive team be aligned with all significant IT spending decisions affecting EBITDA. Second, cloud computing solutions could / should reduce the resources required to run IT operations. As IT operations staff are typically reported as operating expenses, this reduction in staffing can offset the impact of cloud computing spending on EBITDA. Finally, there may be hope on the horizon as financial accounting standards continue to evolve to include more guidance in reporting cloud computing spending, potentially making these decisions more straightforward. Until then, all CIOs must continue to carefully consider all the financial implications of their IT purchases.