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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Cash withdrawn 105 105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
