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Friday, March 16, 2012
Important Concepts in Financial Management
The following are some important terms & concepts related to financial management
Services are what the business sees and understands and if IT Financial Management adopts a service perspective, it will be using a language familiar to the business. Financial Management is concerned with quantifying the value of services and of the assets underlying their provision (Service Valuation). Service Value has two components: the Service Provisioning Value and the Service Value Potential. The first is the actual cost of provisioning the service. This ‘Provisioning Value’ is the sum of the actual costs of delivering the service. This has many similarities to the traditional cost model, where cost elements covering hardware, software, personnel, accommodation etc. are allocated to specific services. Generally, the Provisioning Value represents the minimum value of a service since providers will rarely wish to provide service where the full provisioning cost cannot be recovered. The Service Value Potential is the added value of the service based on what the customer perceives as the financial benefit. The total value of the service is the sum of these two parts. This provides IT and the business with a common language for understanding what IT delivers, what it is worth to the business and, if charging is in place, what a fair price would be.
Demand Modeling, Service Portfolio Management and Service Provisioning Optimization
Service Valuation information is used to forecast the cost of delivery against a pattern of changing demand (Demand Modeling). Financial Management provides financial information that enables the organization to understand the costs and efficiencies of services included in the Service Catalogue and to make decisions about the best way of provisioning these services (Service Portfolio Management and Service Provisioning Optimization).
Financial Management analyses data that enables the organization to translate service costs and patterns of demand into financial resourcing requirements. The total operating costs for the IT service provider will cover all delivered services included in the Service Catalogue, the costs associated with new and changing services in the Service Pipeline and any other costs not otherwise included in service costs. For organizations where financial planning is based on a fixed budget cycle, this information, along with information on expected income, will be translated into budgets.
Governance and compliance
Financial Management will also establish rules for sound financial governance. For example, many organizations will have rules controlling expenditure that will create longer-term financial liabilities. There may be controls over the recruitment of permanent staff because this creates a continuing liability for salaries or redundancy payments. The procurement of fixed assets may mean a continuing commitment for maintenance. Without these controls, an organization can easily build up problems for the future in the form of financial liabilities it cannot meet.
One responsibility of Financial Management is to ensure that the organization complies with all elements of the regulatory framework, including any requirements for statutory returns and reports. Financial Management establishes internal structures and processes, including internal audits, to ensure compliance. Part of this responsibility will concern monitoring expenditure and income against financial plans and budgets to make sure that things are going as planned. Any significant variations from what was planned and expected must be identified and dealt with before they put the organization at risk.
It is important to plan ahead to make sure that business plans match the money available. The product of this planning is a financial plan or budget covering expected expenditure and income for a specified period, usually a (financial) year. Expenditure and income will be divided into categories to facilitate financial planning, management and control.
The budget must reflect the services to be delivered, new projects, investments and other planned changes. It is not an articulation of what the business hopes to do: it is about what can be realistically achieved. Even so, a budget is a plan and plans do not always work out. Budgets should be the best prediction the organization can make, but should include some contingency for the unexpected.
Budgets should show how expenditure and income is likely to change during the budget period (e.g. higher labor and transport costs at seasonally busy times).
Sound financial management requires regular monitoring against budgets. It tells the organization when action is needed to maintain financial control, giving early warning that expenditure is too high or income too low; that planned projects cannot be funded or that others may be brought forward.
The processes in IT accounting allow the IT service provider to account for expenditure and income, providing a breakdown of how costs and income are divided between customers, services and activities. This analysis helps determine the cost-effectiveness of services to make sound decisions about them. It provides details of how costs can be attributed to customers and customer groups, allowing the organization to identify key customers and the impact of their service consumption. The information gathered through the Accounting Process provides budget monitoring with expenditure and income data, which will be used to evaluate the effectiveness of financial controls and to determine if action is required to rectify any significant variations from budget.
The decision whether to charge is a strategic decision to be taken with due care. Charging not only increases the operating costs of the IT service provider, but also increases accountability, exposure and transparency. Customers can compare what they get from IT with what they have to pay, and they can more easily compare their in-house IT provider with alternatives. Charging provides a means to influence customer behavior, shaping demand and usage to match capacity, thereby reducing costs and risk. Without charging, many customers and users will see IT services as free and will make demands on these services with little interest in the financial or operational implications. The introduction of charging helps change attitudes.
Service Investment Analysis
All organizations need to invest wisely and a key role of Financial Management is to evaluate proposals for investment to determine whether they are worthwhile.
Sound Financial Management will require all proposals for investment to include a clear case for making the investment. This case normally takes the form of a Business Case.
A Business Case is a decision support and planning tool that projects the likely consequences of a business action. The core of the Business Case is usually a financial analysis, but the justification of investments frequently depends on more than financial considerations.
Financial Management, in conjunction with business managers and other key stakeholders, will assess the business case in relation to the scale of the investment and the anticipated return, the impact on the business, the timescale for the realization of benefits, the risks and contingencies involved the robustness of the figures and their sensitivity to change. All of these should be covered in a sound Business Case.
It is essential that the Business Case makes it clear how the benefits and costs have been assessed, the assumptions on which it relies and the level of confidence in the figures. Business Cases sometimes depend on highly optimistic or even dubious views of the future, and it is crucial that this is made clear to the decision-makers. For example, it is common for Business Cases to predict staff savings based on individuals saving a few minutes of their time each day through a new investment. All these free minutes are aggregated, costed and presented as a benefit, even though there may be no practical way of realizing a financial saving. It will also evaluate the resource requirements and take a view on whether the organization has the resources and capabilities to deliver. An important concept is that of affordability. An investment may offer outstanding prospects, but the organization should not give approval unless it can afford it.
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