Part II Almost all real businesses in America are required to keep at least three major financial statements available to measure the organization's financial performance, the income statement, the cash flow statement, and the balance sheet In short, these 3 major statements represent the following: - The income statement shows the bottom line: it indicates how much profit or loss a company generates over a period of time-a month, a quarter, or a year.
- The cash flow statement tells where the company's money comes from, and where it goes-in other words, the flow of cash in, through, and out of the company.
- The balance sheet shows a company's financial position at a specific point in time. That is, it gives a snapshot of the company's financial situation-its assets, equity, and liabilities-on a given day.
- When we speak of whether IT appears as profit center or cost center we are speaking of where the money spent by IT or made by IT appears on any or all of these financial statements. Once the IT manager understands how these statements relate to the business goals and strategies in the minds of their executive managers, peers, and partners, it is much easier to meet not only IT objectives but business objectives as well.
Another way to understand the interrelationships is as follows:- The income statement tells you whether your company is making a profit.
- The balance sheet tells you how efficiently a company is utilizing its assets and how well it is managing its liabilities in pursuit of profits.
- The cash flow statement tells you whether the company is turning profits into cash
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For the purpose of these articles I will focus primarily on the income statement. Mind you, any manager or employee of a large corporation should be as familiar with all these statements as they are with the cafeteria menu but that is not always the case. They are usually printed with every company annual report. These days almost all such information for every corporation filing with the SEC can be found on the Internet. They are readily available and should be taken advantage of no matter what level you work at. Certainly senior executives like CIOs, Senior VPs, and directors should be as involved in what these reports say as knowing where to find them. If for no other reason, to know whether the financial health of their company is going to not only be accommodating to IT initiatives but also accommodating to maintaining the current IT personnel. This may seem like common sense, but the feeling that IT and "techies" exist in a world all their own is, unfortunately, still as prevalent as it was 20 years ago. I believe this is part of the reason why economic downturns have a tendency to hit IT departments first and particularly hard. It is very easy for senior managers to ask the question, "Why are we paying so much for IT? Just so I can get management reports on my PC?" Rarely does anybody respond with a clear, well thought out answer.This has proven dangerous in the past not only for IT personnel but also to those responsible for "trimming" the fat. More often than not, people with the knowledge base to keep a good part of an organization running smoothly are let go simply because no one at a certain level understands exactly what they do. Of course, this is not confined to IT departments. Also, ignorance can be just as instrumental in IT departments becoming bloated as it is to their becoming increasingly undermanned. Businesses are in business to make money and unless they are doing so, they probably won't be in business for long. It is the task of the people running businesses to determine the best ways to not only make money but to reinvest that money to make even more money. The people that usually make these determinations are usually the "business" managers, from salespeople and marketing exports, all the way to the Chief Executive Officer. Their role is to find ways to "make" money. Programmers, systems administrators, database managers, systems analysts, have traditionally been looked upon as people that "spend" money, granted for the good of the organization as a whole, but they are not the ones driving in the income, even if they happen to work for technology companies. They are more often concerned with the latest version of software and maintenance contracts than shareholder value and earnings reports. Yet it is those very concepts that determine where and how the company's hard earned money is going to be spent. In the past, as the thirst for data fueled financial, scientific, and manufacturing spending on computers, software and personnel, it was taken for granted that this was all simply a part of the costs of doing business. But now, more than ever, IT managers have to find ways of "adding" to the bottom line. The first question for any manager including the IT manager is, "Just what is the bottom line?" Of course, we all know the intuitive answer, "how much money we've spent and/or how much money we have?" Anybody who balances his or her own checkbook knows this. But how do we put this into language that both a CFO and a CIO can understand? What is an Income Statement?
All for-profit organizations need to define and measure the profit they make (or don't make). The income statement is the most direct way a corporation can express this. How does an income statement present this profitability picture? It starts with a company's revenues: how much money has come in the door from its operations. Various costs-from the costs of making and storing its goods, to depreciation of plant and equipment, to interest and taxes-are then deducted from the revenues. The bottom line-what's left over-is the net income or profit. All for-profit organizations need to define and measure the profit they make (or don't make). The income statement is the most direct way a corporation can express this. How does an income statement present this profitability picture? It starts with a company's revenues: how much money has come in the door from its operations. Various costs-from the costs of making and storing its goods, to depreciation of plant and equipment, to interest and taxes-are then deducted from the revenues. The bottom line-what's left over-is the net income or profit.
Consider the following income statement for Acme Widget Corporation
| | | | Retail sales | $ 2,000,000 | | Corporate sales | $ 1,000,000 | | Total sales revenue | $ 3,000,000 | | Cost of goods sold | $ (1,500,000) | | | | | Operating expenses | $ (800,000) | | Depreciation expense | $ (50,000) | | Earnings before interest and taxes | $ 650,000 | | | | | Interest expense | $ (110,000) | | Earnings before income tax | $ 540,000 | | | | | Income tax | $ (300,000) | | | | | Net income | $ 240,000 |
Without going into details on each term, the bottom is just that. The Acme Widget Company earned a profit (net income) of $240,000. So if you're the CIO of Acme Widget Company pitching a big IT project, chances are you don't want to submit a projected budget for $300,000. This is not rocket science. However, the real item of interest here is not just the "bottom line" but also two of its contributing items, the key items named "costs of goods sold" and "operating expenses". If you notice, the $1,600,000 next to costs of goods sold is listed in parenthesis. This means this number is one of the items subtracted from "gross profit". In other words, it determines how much it "costs" to produce its widgets. If the company uses technology to make its widgets, like a computerized stamp press machine, this may contribute to the total costs of making the widgets. But most likely any "IT" in this case would fall under operating expenses. Operating costs differ from "Costs of goods sold" in that it is defined as the costs of business not directly a part of simply manufacturing widgets. It does not include "widget stuff" or other raw materials, or the direct labor costs of whoever runs the machinery. Operating costs do define just about everything else including administration, rents, sales, marketing, and, usually IT. Keep in mind, although most accountants try to follow a general standard known as Generally Accepted Accounting Principles (GAAP), there is still a notable amount of interpretation involved in deciding what items go where (as you're probably keenly aware if you've been following the latest headlines...). The "operating expenses" side of the income statement becomes increasingly important in a tight economy because this is usually the first area that managers look to when "improving corporate health". Decreasing "costs of goods sold" usually involves complexities such as reorganizations and reevaluating supply and value-chains. These are usually considered long-term initiatives and sometimes quite difficult to manage. Sometimes, short term fixes to either internal or external financial woes need to be dealt with by more immediate action. Keep in mind, although most accountants try to follow a general standard known as Generally Accepted Accounting Principles (GAAP), there is still a notable amount of interpretation involved in deciding what items go where (as you're probably keenly aware if you've been following the latest headlines...). The "operating expenses" side of the income statement becomes increasingly important in a tight economy because this is usually the first area that managers look to when "improving corporate health". Decreasing "costs of goods sold" usually involves complexities such as reorganizations and reevaluating supply and value-chains. These are usually considered long-term initiatives and sometimes quite difficult to manage. Sometimes, short term fixes to either internal or external financial woes need to be dealt with by more immediate action. Keep in mind, although most accountants try to follow a general standard known as Generally Accepted Accounting Principles (GAAP), there is still a notable amount of interpretation involved in deciding what items go where (as you're probably keenly aware if you've been following the latest headlines...). The "operating expenses" side of the income statement becomes increasingly important in a tight economy because this is usually the first area that managers look to when "improving corporate health". Decreasing "costs of goods sold" usually involves complexities such as reorganizations and reevaluating supply and value-chains. These are usually considered long-term initiatives and sometimes quite difficult to manage. Sometimes, short term fixes to either internal or external financial woes need to be dealt with by more immediate action. Of course, lay-offs aren't the only means of reducing operating costs. Generally, less spending on advertising, traveling, and finding new and more efficient means of manufacturing also can contribute to reduced costs. However, larger fortune 500 companies and even small companies can be more pressed by the demands of equity investors, and Wall Street in general, usually rely on more dramatic effects. Wall Street analysts and corporate investors need to "know" these changes are taking place in order to reassess their investment positions, hence, the real meaning of the term "public" in public corporations. The stigma that was once associated with "lay-offs" and downsizing prior to the 1980s is long gone and its become almost fashionable to have a round of lay-offs every now and again, not just to trim costs, but to keep a "trim" workforce in general. And this brings us back to the "Why are we spending so much on IT?" argument. Well, although the answer isn't necessarily a simple one, it can be an understandable one when framed the right way. Funding the IT project The last two article took a look through a peephole at the "large" view of corporate finance in relationship to IT funding. Part III Funding the IT function Part IV
PSA software also lends itself to billing and invoicing, a function long used by external service firms. Internal IT departments are not, strictly speaking, in business to make money, but they can still make use of these billing functions. "If some of our CTOs have their way," Brzozowski says, "they will use the software to generate 'bills' that they will send to Merrill Lynch every month. ... PSA can really show the top brass what they are paying for."Charting IT's costs
By Mark Leon
January 18, 2002, http://www.infoworld.com/
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