How To Balance Capital And Operating Budgets

IT decision makers manage two kinds of budgets: capital and operating. By balancing the combination of IT spending across these two budgets you can improve IT/business alignment and increase IT business value.

Robert Garmaise

What Is The Capital Budget?

Capital IT budgets present plans for the acquisition (or disposal) of IT assets that deliver benefits to the company over a long period of time (typically two to five years). They are listed on the company's balance sheet and depreciated over the asset's useful life. For a majority of small and midsize business IT departments, capital budgets include desktop hardware, applications, network hardware, and servers.

What Is The Operating Budget?

Operating IT budgets present the costs involved in running the IT department on a day-to-day basis. Items in the operation budget deliver short-term benefits (less than a year) and are usually classified as expenses on a company's income statement. Typical operating budget line items include IT staff and consulting.

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The Impact Of Leasing And Outsourcing

The growth of leasing and outsourcing is changing the way IT decision makers in the SME market think about these traditional budgeting definitions. Until recently, most of an organization's IT infrastructure was owned by the business. Desktops, laptops, networks, peripherals, servers, and storage devices were all listed as assets on the balance sheet.

In an effort to capture the vast revenue potential of the small and midsize market, hardware vendors and outsourcers have extended their services to the cash-strapped IT department. Once a component of an IT infrastructure is leased from a vendor or outsourced to a third party, that component is no longer an asset owned by the business. Instead, the cost associated with providing that piece of infrastructure becomes an operating expense on the income statement.

Striking The Right Balance

As an IT decision maker, it is important to find the optimal balance between the two budgets. According to Info-Tech's IT Priorities Report there is a one-third/two-third split between capital acquisition (33%) and operating expenditure (67%) for the majority of small and midsize businesses. Although there are no steadfast rules governing optimal ratio balance, the following pros and cons detail some of the financial and strategic impacts of using capital versus operational spending to drive the IT function.

Capital Spending

Pros

• IT projects that deliver long-term benefits increase the value of the business and should be recognized as assets on the balance sheet.
• Capitalization reduces short-term expenses on the income statement and increases short-term profit.

• Organizations heavily invested in fixed capital IT assets have difficulty adjusting to quickly changing business requirements.
• Capitalization doesn't help the business decrease its taxable income.

Operational Spending

Pros

• Increasing the businesses' operating expenditure decreases taxable income.
• Because money isn't tied up in fixed assets, IT spending is more flexible and the IT department can quickly adjust to changing business requirements.

Cons

• Every dollar not locked into a fixed cost is exposed to competing business needs.
• It is difficult to maintain a long-term vision with operational spending. Developing strategic IT competencies requires advanced IT management skills.

Recommendations

1. Review past and current capital and operating budgets. Every IT decision maker should know how IT spending is balanced between capital acquisition and operating expenses. Using industry benchmarks will help create a more complete context for understanding the organization's spending tendencies.
2. Find the optimal balance between capital and operational spending. Work with business leaders to find the IT cost structure that best aligns with business goals and objectives. Look at the economic model governing the business and industry. This will help determine what IT cost structure can help the business remain competitive.

Bottom Line

IT decision makers should be able to discuss the difference between capital acquisition and operational expenditure. Finding the right balance between the two can increase IT/business alignment.

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Robert Garmaise is VP of research and product strategy with Info-Tech Research Group. Before joining Info-Tech, he served in senior roles for several companies, including Blockbuster Canada, Workbrain, Monitor Company, Canadian Pacific, McKinsey, and Microsoft. Rob is a graduate of the J.L. Kellogg Graduate School of Management at Northwestern University and has an undergraduate degree in mathematics from Harvard University.