Cloud being the fundamental technology to enable digital transformation is becoming the new standard. Amidst, all the excitement, the tide is turning in the minds of the Chief Financial Officer (CFO) regarding the adoption of cloud solutions.
With its on-demand network access of shared resources, the cloud gives enterprises the flexibility they never had before to deploy new applications, quickly respond to opportunities or scale up to meet customer’s ever-growing demands. It promises lower costs, increased productivity, and greater business agility. Going by the numbers, according to Deloitte’s 2018 global outsourcing survey, 93% of business executives claimed to adopt or consider adopting the cloud. With these welcoming benefits, no wonder it is rapidly gaining popularity among IT leaders.
Why the reluctance to adopt cloud?
It’s certain that the financial business case is there. By choosing cloud, one leverages its pay-as-you-go model freeing one from the IT burden and business process complexity of the past, as there is no infrastructure to maintain. It’s like ‘leasing’ a quantum of infrastructure and supporting elements from a cloud service provider and making periodic payments based on utilization. This system works excellent for small and mid-sized enterprises, as it gives them the competitive advantage of using the best technology without paying an upfront cost.
In the case of larger enterprises, the move to cloud implies that the expenditure shifts from Capital Expenditure (CapEx) to Operating Expenditure (OpEx). This leads the CFOs to believe that there will be a direct negative impact on earnings before interest, tax, depreciation, and amortization (EBIDTA), as no new asset has been purchased and no depreciation has been accounted for. With EBIDTA being the primary measure for analysts and investors, they feel that their organization will be poorly received in the outside world, hence, comes their hesitation to the champion cloud.
Looking from a bigger perspective, it is true that intervening years could be punishing, but with CapEx costs progressively moving to OpEx, the balance sheet could eventually even out, and the EBITDA could start increasing again. In fact, CFOs can help drive higher valuations through the cloud by leveraging new changes in the accounting industry as listed below:
1. Reservation discount: An option to save with cloud
For enterprises moving into the cloud from a CapEx style budget, cloud service providers and hosting vendors offer an option termed as ‘Reservation Discount’ that reduce cost by 30-65%. This discount is a quick fix to decrease an organization’s monthly operational spending, usually involving either a commitment to use a resource for a period of one to three years or payment of an upfront cost. But with this benefit also comes a drawback. Choosing to reserve capacity prematurely can lead to having excess capacity, hence, limiting the cloud cost reduction ability. Therefore, careful analysis of capacity requirement seems to be a mandate.
2. Accounting treatment: Evolution of new standards
In the past few years, the reporting structures for the financial treatment of cloud investments have significantly changed and it is certain that they will evolve with time. Recently, in the mid of 2018, the Financial Accounting Standards Board (FASB) released guidelines that cover standards of how customers should account for implementation costs of cloud computing service arrangements.
Key listed provisions:
- Capitalize implementation costs related to a hosted cloud arrangement service by applying the internal-use software guidance
- Capitalize or expense implementation costs by analyzing what stage of the project the costs were incurred and the nature of the costs; the capitalized implementation costs to be amortized over the term of the hosting arrangement
- Do not capitalize costs related to training, re-engineering, and data conversion
Capitalized implementation costs and the related amortization of those costs to be reported on the balance sheet as other assets, on the income statement as an operating expense, and in the statement of cash flows as an operating activity.
As we have seen that cloud solutions help to transform organizations and redefine the strategic use of information technology. Yet, the need to balance this for quick turnarounds with traditional rules of accounting may seem a risky endeavor, especially with the risk of falling EBITDA. However, the accounting industry is actioning on the pressure that enterprises are under as well as the positive outcomes to the economy based on the adoption of modern technology initiatives such as the cloud. It is to be expected that with the right approach of capacity planning by the CIO and the careful judgment by the CFO to apply new standards of accounting prospectively or retrospectively, the cloud can evolve into a win-win situation for the enterprise.