Financial Management

One goal of Financial Management is to ensure proper funding for the delivery and consumption of services. Planning provides financial translation and qualification of expected future demand for IT Services. Financial Management Planning departs from historical IT planning by focusing on demand and supply variances resulting from business strategy, capacity inputs and forecasting, rather than traditional individual line item expenditures or business cost accounts. As with planning for any other business organization, input should be collected from all areas of the IT organization and the business.

Planning can be categorized into three main areas, each representing financial results that are required for continued visibility and service valuation:

Operating and Capital (general and fixed asset ledgers)
Demand (need and use of IT services - discussed earlier in this chapter)
Regulatory and Environmental (compliance).

Operating and Capital planning processes are common and fairly standardized, and involve the translation of IT expenditures into corporate financial systems as part of the corporate planning cycle. Beyond this, the importance of this process is in communicating expected changes in the funding of IT Services for consideration by other business domains. The impact of IT Services on capital planning is largely underestimated, but is of interest to tax and fixed asset departments if the status of an IT asset changes.

Regulatory and Environmental-related planning should get its triggers from within the business. However, FM should apply the proper financial inputs to the related services value, whether cost based or value based.

Confidence is the notion that financial inputs and models for service demand and supply represent statistically significant measures of accuracy. Data confidence is important for two reasons: 1) the critical role data plays in achieving the objectives of Financial Management, and 2) the possibility of erroneous data undermining decision making.

Since Financial Management performs unique financial translation and qualification functions, there is an obligation to ensure that the confidence level of planning data and information is high. Questions about its accuracy will undermine its perceived value. It is therefore important to follow good security practices for access and rights management so that information quality is not compromised. Planning confidence is ultimately a combination of serviceoriented demand modelling translated into measurable financial requirements with a high degree of statistical accuracy. The financial requirements act as inputs to critical business decision making.

More on Financial Management

Financial Management - Accounting

Accounting within Financial Management differs from traditional accounting in that additional category and characteristics must be defined that enable the identification and tracking of serviceitilfoundations.comriented expense or capital items.

Service recording - the assignment of a cost entry to the appropriate service. Depending on how services are defined, and the granularity of the definitions, there may be additional sub-service components.
Cost Types - these are higher level expenses categories such as hardware, software, labour, administration, etc. These attributes assist with reporting and analysing demand and usage of services and their components in commonly used financial terms.
Cost classifications - there are also classifications within services that designate the end purpose of the cost. These include classifications such as:
- Capital/operational - this classification addresses different accounting methodologies that are required by the business and regulatory agencies.
- Direct/indirect - this designation determines whether a cost will be assigned directly or indirectly to a consumer or service.
  - Direct costs are charged directly to a service since it is the only consumer of the expense.
  - Indirect or 'shared' costs are allocated across multiple services since each service may consume a portion of the expense.
- Fixed/variable - this segregation of costs is based on contractual commitments of time or price. The strategic issue around this classification is that the business should seek to optimize fixed service costs and minimize the variable in order to maximize predictability and stability.
- Cost Units - A Cost Unit is the identified unit of consumption that is accounted for a particular service or service asset.

As accounting processes and practices mature toward a service orientation, more evidence is created that substantiates the existence and performance of the IT organization. The information available by translating cost account data into service account information dramatically changes the dynamics and visibility of service management, enabling a higher level of service strategy development and execution.

Financial Management - Costs

Direct versus indirect costs are those that are either: 1) clearly directly attributable to a specific service, versus 2) indirect costs that are shared among multiple services. These costs should be approached logically to first determine which line items are sensible to maintain, given the data available and the level of effort required. For example, hardware maintenance service components can be numerous and detailed, and it may not be of value to decompose them all for the purpose of assigning each to a line item cost element. Once the depth and breadth of cost components are appropriately identified, rules or policy to guide how costs are to be spread among multiple services may be required. In the hardware maintenance example, rules can be created so that a percentage of the maintenance is allocated to any related services equally, or allocation rules could be based on some logical unit of consumption. Perceived equality of consumption often drives such decisions.

Labour costs are another key expenditure requiring a decision to be made. This decision is similar to that of 'direct versus indirect' above, compounded by the complexity and accuracy of time tracking systems. If the capability to account for resources allocated across services is not available, then rules and assumptions must be created for allocation of these costs. In its simplest form, organizing personnel costs across financial centres based on a service orientation is a viable method for aligning personnel costs to services. Similarly, administration costs for all IT Services can be collected at a macro level within a financial centre, and rules created for allocation of this cost amongst multiple services.

Variable cost elements include expenditures that are not fixed, but which vary depending on things such as the number of users or the number of running instances. Decisions need to be made based on the ability to pinpoint services or service components that cause increases in variability, since this variability can be a major source of price sensitivity. Pricing variability over time can cause the need for rules to allow for predictability. Associating a cost with a highly variable service requires the ability to track specific consumption of that service over time in order to establish ranges. Predictability of that cost can be addressed through:

Tiers - identifying price breaks where plateaus occur within a provider so that customers are encouraged to obtain scale efficiencies familiar to the provider.
Maximum cost - prescribing the cost of the service based on the maximum level of variability. This would then most likely cause overcharging, but the business may prefer 'rebates' versus additional costs.
Average cost - this involves setting the cost of the service based on historical averaging of the variability. It would leave some amount of overor under-charge to be addressed at the end of the planning cycle.

Financial Management - Implementation Checklist

The tracks indicated below serve as a sample checklist of recommended implementation steps that should be addressed. The guidance below is not intended to be a project plan, but a representation of a phased approach to implementation.

Stage 1 - Plan

Critical questions about the business and IT culture should be addressed prior to moving forward with implementing Financial Management. Refer to previous chapters and ITIL publications for a discussion on organizational considerations that should be considered before designing processes.
Key to setting of practices is assessing the corporate culture. Geographical considerations, such as one location versus global distribution, will have additional regulatory and compliance considerations.
Identify all internal and external contacts that provide and/or receive IT financial information.
Be clear about IT and business expectations. What deliverables do both organizations expect from the implementation? Does the business or IT expect a chargeback system? Is there currently a Service Catalogue implemented and awaiting pricing?
Determine systems that are in place from which Financial Management will receive and contribute data.
Determine the funding or operating model to be used. This will set the tone for the way accounting and valuation will be performed.
Assign responsibilities for the deliverables and outline the activities to be performed.
Prepare the organization chart based on activities that will be performed, the size of the data that will be managed, and tools that are available.
Prepare a policy and operating procedures list.

Track 2 - Analyse

The analysis portion of the implementation should involve gathering indepth details around the planning and funding items previously identified. The most in-depth task will be analysing the data surrounding service valuation and demand modelling.
If either IT or the business holds expectations about deliverables, work backwards to make certain that all processes and information required to produce the expected deliverables are accounted for as part of Financial Management responsibilities. Often, a chargeback methodology drives implementation of Financial Management with perceptions of multiple levels of service. However, as the availability of financial information is analysed, it becomes apparent that collection and reporting of the various levels of demand is not possible and there is no real value in even having multiple levels of service.
Become familiar with current expenses in preparation for creating new valuation and funding documents. There may be immediate issues that come into view after reviewing expenditures. Of critical importance may be the realization that not all IT expenditures are collected into one financial centre. Frequently telecommunications charges are disbursed among numerous business organizations. To properly report and account for services costs, centralization of IT expenditures is a prerequisite.
Once an accounting of all IT expenditures has been completed, service valuation should be performed. Reports should be produced that provide for the first element of valuation pricing of service assets. If the operating model allows for the addition of value-add pricing, then the next step is to add that value to each service to calculate the total price for an IT service. Analysis and calculation of the value-add price will require a great amount of input from Service level management, Availability, Security and Capacity Management. This is a critical calculation since business perception of value and price can be miscalculated and create an unwanted effect.
If during the analysis phase it becomes apparent that Financial Management dependent processes are not available, the plans for implementation must be adjusted. For example, if no IT Services have already been identified, then valuation will be postponed until the catalogue of services has been agreed.

Track 3 - Design

The design phase creates the outputs that are expected from a Financial Management implementation. Working with key contributors and supporters is paramount during this track. Design is done around data inputs and translations, reports, methodologies and models.
Processes - identify all processes in place within IT and design clear hooks into Financial Management.
Valuation Models - should be prepared and tested for appropriateness to the business environment.
Accounting processes - from the learning obtained from the initial accounting of IT expenditures, processes and procedures should be finalized. Reports should be identified that will be pertinent to the operating model and business environment, for example, cost trends by different classifications, and financial analysis of ROI, ROA and TCO.
Chargeback methods - create the chosen chargeback methodology.
Procedures - complete design of FM policies and procedures.
Roles and responsibilities - prepare job descriptions and fill required roles.

Track 4 - Implement

Implementation involves activation of planned processes. The initial input will come from corporate financial systems and Change Management processes. Key hooks to data translations come through:
- Accounting is the first process that receives financial data for translation.
- Change and Demand Management are the first steps in becoming aware of anticipated changes to IT.

Track 5 - Measure

To come full cycle through implementation, measures of success need to be provided on financial trends within funding, valuing and accounting.
It is also important to audit for any credibility gap between the value being received and price being paid as soon as possible. This can be done through providing:
- Concise communication possibly via a balanced scorecard
- Regular communication
- Meaningful data
- Making certain to always map to business strategy.

Financial Management - Return on Investment

Return on Investment (ROI) is a concept for quantifying the value of an investment. Its use and meaning are not always precise. When dealing with financial officers, ROI most likely means ROIC (Return on Invested Capital), a measure of business performance. This is not the case here. In service management, ROI is used as a measure of the ability to use assets to generate additional value. In the simplest sense, it is the net profit of an investment divided by the net worth of the assets invested. The resulting percentage is applied to either additional top-line revenue or the elimination of bottom-line cost.

It is not unexpected that companies seek to apply the ROI in deciding to adopt service management. ROI is appealing because it is self-evident. The measure either meets or does not meet a numerical criterion. The challenge is when ROI calculations focus in the short term. The application of service management has different degrees of ROI, depending on business impact. Moreover, there are often difficulties in quantifying the complexities involved in implementations.

While a service can be directly linked and justified through specific business imperatives, few companies can readily identify the financial return for the specific aspects of service management. It is often an investment that companies must make in advance of any return. Service management by itself does not provide any of the tactical benefits that business managers typically budget for. One of the greatest challenges for those seeking funding for ITIL projects is identifying a specific business imperative that depends on service management. For these reasons, this section covers three areas:

Business case - a means to identify business imperatives that depend on service management
Pre-Programme ROI techniques for quantitatively analysing an investment in service management
Post-Programme ROI - techniques for retroactively analysing an investment in service management.

Financial Management - Value and benefits

The landscape of IT is changing as strategic business and delivery models evolve rapidly, product development cycles shrink, and disposable designer products become ubiquitous. These dynamics create what often appears to IT professionals as a dichotomy of priorities: increasing demands on performance and strategic business alignment, combined with greater demand for superior operational visibility and control. Much like their business counterparts, IT organizations are increasingly incorporating Financial Management in the pursuit of:

Enhanced decision making
Speed of change
Service portfolio management
Financial compliance and control
Operational control
Value capture and creation.

IT organizations are conceding they are quite similar to market-facing companies. They share the need to analyse, package, market and deliver services just as any other business. They also share a common and increasing need to understand and control factors of demand and supply, and to provision services as cost-effectively as possible while maximizing visibility into related cost structures. This commonality is of great value to the business as IT seeks to drive down cost while improving its service offerings. The framework below illustrates the commonality of interests and benefits between the business and IT

Service and strategy design both benefit greatly from the operational decisionmaking data that Financial Management aggregates, refines and distributes as part of the Financial Management process. Rigorously applied, Financial Management generates meaningful critical performance data used to answer important questions for an organization:

Is our differentiation strategy resulting in higher profits or revenues, lower costs, or greater service adoption?
Which services cost us the most, and why?
What are our volumes and types of consumed services, and what is the correlating budget requirement?
How efficient are our service provisioning models in relation to alternatives?
Does our strategic approach to service design result in services that can be offered at a competitive market price, substantially reduce risk or offer superior value?
Where are our greatest service inefficiencies?
Which functional areas represent the highest priority opportunities for us to focus on as we generate a Continual Service Improvement strategy?

Without meaningful operational financial information, it is not possible to answer these questions correctly, and strategic decisions become little more than instinctive responses to flawed or limited observations and information, often from a single organizational unit. Such methods can often incorrectly steer strategy, service design, and tactical operational decisions.

Whereas Financial Management provides a common language in which to converse with the business, Service Valuation provides the storyline from which the business can comprehend what is actually delivered to them from IT. Combined with Service level management, Service Valuation is the means to a mutual agreement with the business regarding what a service is, what its components are, and its actual cost or worth.

Additionally, the application of Service Valuation discussed in this chapter transforms the discussion and interaction between IT and the business customer, and the way customers plan for and consume IT Services. The use of Financial Management to provide services with cost transparency (such as via a Service catalogue) that can then be clearly understood by the business and rolled into planning processes for demand modelling and funding, is a powerful benefit. Such maturity in an IT operation can generate enormous cost savings and Demand Management capabilities.

Financial Management - Variable Cost Dynamics

Variable Cost Dynamics (VCD) focuses on analysing and understanding the multitude of variables that impact service cost, how sensitive those elements are to variability, and the related incremental value changes that result. Among other benefits, VCD analysis can be used to identify a marginal change in unit cost resulting from adding or subtracting one or more incremental units of a service. Such an analysis is helpful when applied toward the analysis of expected impacts from events such as acquisitions, divestitures, changes to the Service Portfolio or service provisioning alternatives etc.

This element of service value can be daunting since the number and type of variable elements can range dramatically depending on the type of service being analysed. The sensitivity analytics component of Variable Cost Dynamics is also a complex analytical tool because of the number and types of assumptions and scenarios that are often made around variable cost components. Below is a very brief list of possible variable service cost components that could be included in such an analysis:

Number and type of users
Number of software licences
Cost/operating footprint of data centre
Delivery mechanisms
Number and type of resources
The cost of adding one more storage device
The cost of adding one more end-user licence.

The analysis of Variable Cost Dynamics often follows a line of thinking similar to market spaces, covered elsewhere in this publication. The key value derived from this body of knowledge focuses on more precisely determining what fixed and variable cost structures are linked to a service, and how they alter based on change (either incremental or monumental), what the service landscape should look like as a result, how a service should be designed and provisioned, and what value should be placed on a service.

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