You Decide Scenario _

Introduction

Budgeting is a very important part of the managerial role of any department manager. A budget helps the department establish the amount of money it will need in order to operate for a fiscal year. By creating a budget, this guarantees that your department will get a piece of the pie for general operating costs, and in some cases, proposed projects. If your budget is approved, you can breathe easy, knowing that you have the money that you need to operate your department for the next year.

Traditional organizational budgets & accounting systems are activity-oriented, with expenses gathered and reported by organizational units. IT Budgets represents a large organizational strategic investment for many corporations; hence, it is critical for IT managers, CIO, and CFO to understand what needs to be considered in creating an IT departmental budget.

Budgeting is not always an easy process simply because it requires good working knowledge and understanding of the financial aspects of the organization. Depending on the type of organization for which you work, the budget might serve as a profit plan. In other organizations like nonprofits, the budget might serve as a cost savings plan. According to Engler (1993), a "budget is a financial plan that sets forth the resources necessary to carry out activities and meet financial goals for a future period of time" (p. 394). With that in mind, let's look more closely at budgeting and why it is important.

Why Budget?

Budgeting allows the company to incorporate the organizational goals into a more formal plan for the upcoming year. The budgeting process also means that all departments must work in concert to create a formalized plan of how money will be spent in order to reach organizational goals. A budget also holds the department accountable in spending only the money it is allocated. It's like sending a child to the movies with $20. If the child wants to see the movie, have popcorn, and have a soda, he or she may have to forego playing the video games in the lobby in order to have the popcorn and soda, or else decide to skip the popcorn to play the game. In either case, the child is only allocated a certain amount of money, and that's all that he or she gets. The child must spend within his or her budget.

Companies also use budgets as a way to measure employee performance. If you have a manager who is consistently going over budget, there might be performance issues that the company may not otherwise know about. With a budget, the company can measure and recognize poor performance.

Typically, there will be a budget committee within an organization, depending on size. The budget committee will make the final decision on the allocation of funds to each department. Of course, department managers play a big role in creating and preparing the budget since it includes them in the process and ensures buy-in. Therefore, budgeting is a collective effort, rather than the responsibility of just one person, or of upper-level managers. Anyone who is allowed to spend money should be included in the budgeting process, which could mean many layers of budgeting. For instance, in an IT department, the CIO might be the one who is responsible for presenting the finalized IT budget to the budget committee, but the different managers within the IT department might have put the budget together. This collective effort ensures that all costs are identified.

Budgeting Process Fundamentals

Each company has its own budgeting process, including a timetable for budget development. However, in general, most companies create a master budget on a yearly basis and update it throughout the year. When it is time to develop next year's budget, there are two major processes used for development: incremental budgeting (also known as run-rate budgeting) and zero-based budgeting.

Incremental (Run-Rate) Budgeting

Incremental budgeting assumes that next year's operations will be similar to this year's operations. It uses the current year's revenues and expenditures as the basis for next year's budget. Incremental budgeting works well in areas that are well established, or where the economic environment is not changing quickly. The normal approach to incremental budgeting is to compare the current year's actual expense history against the current year's budget. Then identify the best estimate for total current year actual expenses, and use this actual expense estimate as the base for establishing next year's budget.

Zero-Based Budgeting

Zero-based budgeting starts with a clean sheet. In other words, this year's revenues and expenditures are not used for the basis of the budget. Instead, assume that each budget item starts with a zero amount. This forces the manager to justify each and every budget item. This budgeting method helps to eliminate carryover of poor assumptions made during the previous year. It is also useful when the company is experiencing reduced revenues, or when the economic environment is changing rapidly. The steps for this process, as listed in the text (p. 145), are as follows:

1. Separate each department activity into a decision package.

2. Rank these decision packages in terms of their importance.

3. Allocate the proposed budget into the various decision packages.

4. Submit the decision packages for approval.

FISCAL Annual Budgets

The budgeting process guides each department and the company in identifying expected revenues and expenses for the coming year. This helps the company plan its activities over the year. Even though every effort is made to plan for the coming year, there are still emergencies or unidentified opportunities that arise. The budget process must include ongoing processes for handling items that require budgetary funding, but were not identified during the yearly budget planning sessions.

Annual budgets are also known as fiscal budgets which are grouped as operating expenses and capital expenses.

Operating Expenses (OPEX)

Operating expense is an expense required for the daily operations of the business.This type of expenses include administrative expenses (e.g., salaries and benefits), cost of utilities, the cost of goods sold, R & D cost,etc.

Capital Expenses (CAPEX)

A Capital expenditure is an investment done by the business, which benefits to the firm would take more than a year to materialize. CAPEX budgets are used for identifying and providing funds for assets used long term.  This type of assets are recorded in the company's balance sheet and it is depreciated over the total useful life of the asset; Next, a periodic depreciation is expense is reported in the company's income statement

Most companies have their own definition of what belongs on the capital budget, but the majority of the time, the accounting department is the main resource for determining if an item can go on the capital budget. The general requirement for placing an item on a capital budget is a cost threshold and a useful life threshold. For example, your company may define a capital item as any item that costs more than $100,000 and has a useful life of more than one year. Please remember, this is just a guideline and the accounting or finance department should be consulted for a detailed definition of a capital item.

Discrepancies between the conceptual vs. practical budgeting approach are noticeable when referring to IT Budgeting; therefore, it is important for IT managers to understanding these differences.

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IT BUDGET

In general, IT managers group their spending into two categories: operating cost and strategic investments.

IT Budget = Operations Costs + Strategic Investment

IT - Operations Costs

The operating cost includes maintenance cost, support cost, and overhead expenses. This budget is set apart to manage the IT department operations for the up-coming year. On average it represents 76% of the IT budget.

Maintenance cost (i.e., IT operating expenses) includes for example: storage and network cost

Support cost includes the cost of IT services delivered/sold to other units, independently of the sourcing mechanism used (i.e., in-house, or outsource.)

Overhead expenses include administrative overhead, such as the cost incurred in accountants or receptionists.

The major components of an IT operations cost include the following items.

· Hardware—items such as computers, servers, and network equipment

· Software—items such as applications, databases, operating systems, and network management

· Personnel—salary and benefits

· Data communications—items such as telephone systems, WANs, and ISP services

· Other—items such as office expenses, travel, and training

Since the operating budget is concerned with the day-to-day running of the IT department, it is a very important tool in managing the IT department. It is one of the major scorecards used by upper management to grade the IT department. IT managers must proactively manage the budget and any variances that occur between the budgeted funds and actual expenditures. If there are large variances, then the IT manager must quickly determine the reason for the variance and how to mitigate the effects of the variance. It is rare that, should a department go over its operating budget, it is given more money. Furthermore, if the manager is not good at managing these variances, areas such as training and development are sometimes sacrificed, which are very important to the IT staff. Variances can not only affect money, but they can also affect morale.

IT - Strategic Investment

Strategic investments are aligned to the organization's strategic objectives. These funds represent on average about 24%  of the total IT budget, which is set apart specifically for new initiatives and technology procurement designed to bring new business value.

It can include:

· Business improvement initiatives,

· Business enabling Initiatives,

· Business opportunity projects, and

· IT infrastructure

Strategic investments projects can be IT-OPEX  or IT-CAPEX depending on how the organization has defined them.

IT-CAPEX

Most IT projects are handled through the capital budget. Once projects have been approved through the project justification process, they are placed on the capital budget. Decisions on how best to fund the projects are made through the accounting/finance department. These decisions are made based on many factors, including the company's balance sheet, lender agreements, cash on hand, budget forecasts, and financial performance.

For the most part, capital budgeting is a separate process from operating budgets, although the same budgeting processes (incremental or zero-based) are used for both budgets.

IT-OPEX

At its simplest, the operating budget consists of all revenues and expenditures that are not on the capital budget. The IT operational budget is used to plan and control the annual operating costs for the IT department. Items on this budget are those that are required for daily operation and support of the installed infrastructure, hardware, software, end users, and so forth.

Remember, any budget is just a plan, which indicates that there is money to support a certain function; it does not automatically guarantee that the money is there.

IT - Cost Allocation

Cost allocation is the process of allocation the cost of the services provided by IT department to other units.

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Corporate Process

Corporate Processes that influence the IT plans and Budgets include:

· Establishing of a corporate fiscal policy

· Establishing of strategic goals

· Setting of IT spending levels

The next images summarizes these key corporate processes

IT Processes

The Corporate processes presented earlier in a way dictates the various IT processes,

For example:

· Establishing Corporate Fiscal Policy → Sets The Fiscal IT Budget.

· Setting IT Spending Levels → Sets The Functional IT Budget.

· Establishing The Strategic Goals for IT & BU → Determines the IT Strategic Priority Investments.

The image below summarizes the interrelation that exist between the corporate processes and IT processes.

Wrapping Things Up  

Budgeting is an important part of a manager's job. It helps to ensure that funds are available for annual operating and capital costs. These funds might be a profit plan or a plan to save money. Either way, if the department has a budget plan, it can ensure that it is working toward the goals of the organization.

References

Engler, C. (1993). Managerial accounting. Homewood, IL: Richard D. Irwin.

McKeen, J., & Smith, H. (2015). IT Strategy: Issues and Practices (3rd edition). Upper Saddle River, NJ: Pearson Prentice Hall

Brown, C., DeHayes, D., Hoffer, J., Martin, E., Perkins, W. (2012). Managing Information Technology (7th Edition). Upper Saddle River, NJ: Pearson Prentice Hall