What’s not to love about cloud computing? It enables businesses to effectively and efficiently utilize shared hardware, software and other services on an as-needed basis. The cloud model typically moves responsibility for the ownership, maintenance and operations of IT services from an internal IT organization to an external provider. Just ask any Software, Infrastructure or Platform as a Service supplier about the benefits. They can spout them from memory like the Pledge of Allegiance: Efficient Scalability, High Availability, Greater Operational Agility, Disaster Recovery, Workforce Mobility, Increased Security, Reduced Capital Expenditures, and the list goes on. Sounds like great news for any CIO whose plate is overflowing with ‘wake up in a cold sweat’ challenges in all these areas. Where do I sign, right?
“NOT SO FAST!” SAYS THE CFO
Businesses who are considering a move to cloud computing must fully understand the decision could have possible impact on key company financial metrics, including EBITDA. What is EBITDA? EBITDA is defined by Wikipedia as: A company’s Earnings Before Interest, Taxes, Depreciation, and Amortization. EBITDA is an accounting measure calculated using a company’s net earnings, before interest expenses, taxes, depreciation and amortization are subtracted, as a measurement of a company’s current operating profitability.
Why should a CIO be concerned about EBITDA? EBITDA is widely used in many areas of finance when evaluating the performance and valuation of a company. In many cases, EBITDA is also a key metric utilized to determine an executive team’s incentive bonus, including the CIO. Now do I have your attention?
If a business is not using cloud computing and decides to purchase hardware, software and other technology infrastructure, the expenditure is financially reported as a capital expenditure and the asset is depreciated over time. Essentially, capital expenditures have no negative impact on EBITDA. However, cloud computing fees are recorded as an operating expense. Services recorded as an operating expense may negatively impact EBITDA because this metric is adjusted for depreciation of capital expenditures but not for operating expenses.
THE CIO PARADOX
Investing in cloud computing can provide many benefits for the business, including reducing overall IT expenditures. However, because cloud computing expenditures are treated as operating expense, they negatively impact EBITDA, and possibly you and your boss’s compensation. Conversely, purchasing the hardware and software in a business-as-usual model will cost more, but have no negative impact to EBITDA.
WHAT IS A CIO TO DO?
First, it is most important the CIO, CFO, CEO and other decision makers discuss and fully understand the Cloud Computing – EBITDA Paradox. Because the financial implications to the company can be significant, it is imperative that the executive team be aligned on all substantial IT expenditure decisions that impact EBITDA. Second, cloud computing solutions could/should reduce the resources required to run IT operations. Since IT operations personnel are typically reported as operating expenses, this reduction in staff could offset the impact of the cloud computing expenditure on EBITDA. Lastly, there may be hope on the horizon as financial accounting standards continue to evolve to include more guidance on reporting cloud computing expenditures, potentially making these decisions more straight forward. Until then, all CIOs must continue to carefully consider all the financial implications of their IT purchases.