Finance for IT Decision Makers

Michael BlackstaffHugh Pike

Topics

• Michael Blackstaff– IT depreciation– IT financial cases– IT investment evaluation methods– IT leasing

• Hugh Pike– IT outsourcing – financial aspects

Straight line depreciation

0

20

40

60

80

100

120

Book valueMarket value

Years

£000

Loss on disposal

Reducing balance depreciation

0

20

40

60

80

100

120

Book valueMarket value

Years

£0

00

Loss on disposal

Depreciation of upgrades (1)

Up g ra d e 1

Up g ra d e 2

B a se a sse t

Rectangles indicate expected life at acquisition of each element

Depreciation of upgrades (2)

Up g ra d e 1

Up g ra d e 2

B a se a sse t

Rectangles indicate expected life at acquisition of each element

Depreciation of upgrades (3)

B a se a sse t Up g 1 Up g 2

Rectangles indicate expected life at acquisition of each element

Recommended

Financial cases

• Cash flow financial case– a statement of incremental future cash

inflows and outflows – exclude depreciation and losses

• Profit and loss financial case– a statement of incremental future

revenues and expenses– include depreciation and losses

Example

Assumptions £000New company, first yearAll purchases and sales for cashSales 200Expenses, excluding depreciation 160Systems bought for cash 60Depreciation 4 years straight lineResidual value 0

ExampleCash flowReceipts 200Payments, excluding equipment -160Paid for equipment -60Net cash flow -20Profit and lossSales 200Expenses, excluding depreciation -160Depreciation (4 yr straight line) -15Profit 25

Investment evaluation methods

• For cash flow cases:– Net present value

(NPV) – Internal rate of

return (IRR)– Shareholder value

added (SVA)– Payback

• For profit and loss cases:– Return on

investment (ROI)

Exchange rates

Currencies £ $ Sfr £ total

Amounts 100 100 100

Exchange rates 1 2 2.5

£ result 100 50 40 190

Discount factors

Pounds Yr 0 Yr 1 Yr 2 Total

Amounts 100 100 100

Discount factors 1 0.9091 0.8264

Present values 100 90.91 82.64 273.55

Car example

Pounds Yr 0 Yr 1 Yr 2 Yr 3 Total

Amounts -8000 1600 1680 5164 444

Disc factors 13% 1 0.8850 0.7831 0.6931

Present values -8000 1416 1316 3579 -1689

IRR Example - a miniature 'project'

Yr 0 Yr 1 Total

Cash invested -100 -100

Cash withdrawn 105 105

Net cash flows -100 105 5

Disc factors 5% 1.0000 0.9524

Present values -100 100 0

IRR = 5%

Why lease IT?

• Tailored payments• Conserve cash• Preserve lines of credit• Reduce product risk• Off balance sheet• Enhance ratios • Match expenditure to benefits

Operating leases only

**

*

*

Residual value

0

20

40

60

80

100

120

Market valueResidual value

Years

£000

Kinds of lease

0

20

40

60

80

100

Years

£000

Operating lease Finance lease-100

0

RV

ResidualValue (RV)

Leasing considerations

0

20

40

60

80

100

Residual value

Years

£000

• Options priced?• Upgrades?• Extension?• Early termination?• Conversion?• Rolled debt?

IT Outsourcing – financial aspects

Hugh Pike

IT Outsourcing

• Involves– external provision of IT services– transfer of assets and / or people (usually)

• Business perspective– focus on core business– enhanced services– increased accountability / enforceability

• Financial reasons

Financial cases

• Comparative cases– in-house versus out-house– competitive external providers

• Factors for consideration– outsourcing charges & inflation– infrastructure & overheads– service enhancements– personnel (TUPE & retained management)– third party contracts

Financial characteristics

• Cost reduction• Assets off balance sheet (usually)• Cash injection if assets transferred• Reduced in-house headcount (usually)• Smoothing to provide tailored cash flows• Simpler admin and accounting

Evaluation• Decision criteria

– investment decision?– cost reduction techniques

• Benefits versus risks– financial case– other factors

• Business decision– strategic fit– market perception

Top financial tips

• DON'T confuse cash flow and profit• DO use appropriate evaluation methods• DON'T overestimate IT asset life• DO use appropriate depreciation method• DON'T assume the cheapest lease is

necessarily the best• DO consult available financial and

outsourcing expertise when appropriate

Summary

• Michael Blackstaff– IT depreciation– IT financial cases– IT investment evaluation methods– IT leasing

• Hugh Pike– IT outsourcing – financial aspects

Thank you for participating

Michael Blackstaffwww.financial-trainer.comHugh Pikehugh_pike@yahoo.co.uk