Accounting for ignorance

IT directors must know the difference between balance sheets and a profit and loss account, writes Julia Vowler

IT directors must know the difference between balance sheets and a profit and loss account, writes Julia Vowler

Money - or rather the lack of it - has never been more important to corporate IT. With recession biting deeper and deeper into IT budgets, should the head of IT know almost as much about corporate finance as the head of finance?

"The head of IT has always had to be knowledgeable about corporate finance," says David Rippon, chairman of the Elite group of IT directors. "It is an IT director's job to put in place an IT structure to support business, to maximise profitability and to increase sales. Understanding the financial health of the company is vital."

He says the same rule applies to all other aspects of your company. An IT director of a manufacturing company needs to understand manufacturing processes, and so on.

Moreover, as Nick Shepherd, who runs training company Learning Tree's course on finance for non-financial managers, says, "If you don't understand how the business works from a financial standpoint, how are you supposed to judge what information any particular system should provide?"

Finance is, of course, an area as rife with jargon as IT itself, and accountants - like IT folk - often do not realise that others do not understand it, warns Bob Earnshaw, who runs the Institute of Directors' course on finance for non-financial directors.

Historically, there was never a problem because most IT directors were accountants anyway - corporate IT was originally targeted at financial applications. But the generation of technically-trained IT directors without any accountancy training face a steep learning curve.

"They are vulnerable," says Philip Virgo, strategic adviser to the Institute for the Management of Information Systems. "They can be caught between their own finance directors and their suppliers."

Sometimes IT directors need more training than they might think. "The key is to have the confidence and knowledge to make a valid contribution, so they won't be run roughshod by their own financial people. But I am still surprised at the degree of ignorance about our old friends the profit and loss account and the balance sheet," says Shepherd. "IT people often think they already have a reasonable understanding, then come up to me afterwards and say 'I had no idea!'."

But is corporate finance getting more difficult for non-accountants to understand?

"It has always been simple, but has become obfuscated over recent years," says Virgo.

Some obfuscation has, of course, been deliberate, as the investigations into the likes of Enron proved.

Take securitisation, for example. It has become a craze all over the City as a way of releasing cash back into the business, or to pay off shareholders wanting a return on their investment. Beneath the jargon it is actually quite simple.

"You have got an income stream from something that will generate, say, £5m a year for five years, so it is worth £25m, and you sell it for £23m now," he says. "If the next five years look dodgy, and you could do with the money now, then it is no risk and you have got the money immediately."

Having a basic grasp of finance is also crucial in ensuring that contracts with suppliers do not contain any nasty surprises. IT managers should insist that every contract is summarised in plain English, spelling out deliverables and payments.

The issue of capitalising software in corporate accounts (spreading its cost over a number of years, rather than treating it as an expense and taking a bigger hit in the accounts) is another area of finance where IT managers need to be up to speed. IT managers and accounting experts seem to be split over the issue, admitting that it is an accounting grey area.

Spreading the cost of software over several years has both pros and cons, says Rippon. "You can show better results in your first year, but you are mortgaging the future," he says. "My own view is I would rather swallow the cost than spread it. But the more projects you run, the more likely you are to capitalise on their cost."

Outsourcing too, has a strong element of financial engineering. Increasingly sophisticated arrangements, such as setting up joint venture companies between user and supplier, or even issuing bonds on the capital markets to fund the contract, are coming into play, which the IT director needs to understand from a purely financial point of view.

But while there are general principles of corporate finance that IT directors need to understand, they should also remember that each company takes its own stance on accounting.

"Understanding the distinction between capital and revenue expenditure and how it can go wrong also highlights how different companies have different policies on such matters, which leads to quite different bottom lines," says Shepherd.

Moreover, accountancy is not a static field, and IT professionals will have to keep up with changing practices.

"It is quite surprising how dynamic finance and accounting is," says Shepherd. "People tend to think it was etched in stone about the time of Moses and nothing has changed since. New ideas and new ways of accounting are constantly coming along."

Earnshaw says keeping up to date can best be done by reading the financial pages of the newspapers and by checking out the profession's websites, such as www.asb.org.uk. "Keeping a handle on finance is the first rule of surviving the recession," he says.

Training   

More information on the Institute of Directors' finance for non-financial directors course can be found at www.iod.co.uk. The finance for non-financial managers course, run by Learning Tree International, can be booked online at www.learningtree.co.uk.

Understanding corporate finance 

Bob Earnshaw, who runs the Institute of Directors' course on finance for non-financial directors, says corporate finance is not difficult to understand. "One of the major difficulties is the language - the mechanics are quite straightforward. But how the profit and loss account hangs together and relates to the balance sheet is not always easy to grasp," he says.  Here, Earnshaw outlines what IT directors must know about corporate finance:  n To do a good job you must understand cash flow, balance sheet and profit and loss analysis. Matters such as tax are the finance director's responsibility 

  • Cash flow: remember that 75% of companies that go broke are making money 
  • Cost assumptions: the profit and loss account can look so solid and scientific, yet it is based on a huge amount of judgement and estimation 
  • Capital budget measures: companies spend a lot of money on IT, so an IT director must know what the key measures are, such as net present value [to make a decision]. As the financial environment becomes riskier, the true value of money over time becomes more significant, especially in longer projects. The decision to outsource is also affected by capital budget measures  
  • Balance sheet: this is without doubt the area non-finance people find most difficult. Most have profit and loss experience, but the balance sheet talks about assets and deals with resource management.

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