We are all Pavlov’s dogs. Software developers and marketing specialists are among the many to exploit his discovery that you can condition a dog to drool at the drop of a (metaphorical) hat, and we are now bombarded with so many ‘conditioning messages’ than we can struggle to make an independent choice about which food to eat for breakfast, let alone which business system to use, or how to pay for it.
So it can be difficult to see beyond the hype that has positioned the all-singing, all-dancing cloud as the most cost-effective solution to any business computing need (sometimes it is, sometimes it isn’t). But it’s worth taking a look: even organisations that don’t want to pay up-front for the software or services or hardware they need, should be aware of the various ways to finance this approach.
"If minimising your up-front spend is your main reason for considering cloud computing, it isn’t the only way to spread the cost,’ says Richard Anning, the accountant who heads the IT faculty at the Institute of Chartered Accountants in England and Wales (ICAEW). "If you want to avoid taking the hit all in one go, you can also do this using contract hire, hire purchase, a loan, an operating lease or a finance lease."Unfortunately, deciding whether the right approach for any business or scenario is the public ‘pay-as-you-go’ cloud, or one of these alternatives, is not simple or straightforward.
None of these approaches is inherently superior financially, they are all treated differently for accounting and tax purposes, (depending on the contract, and statutory legislation), and in the current economic cirumstances your decision will need to be a pragmatic one.The approach you take will be determined by the financing options that are available to your particular business.
"How easy the money is to get at will be a big factor," admits Anning. Access to Software as a Service (SaaS) or Infrastructure as a Service (IaaS) in the public cloud are within the reach of the smallest and youngest start-up, while even businesses with a healthy credit history can struggle to secure hire purchase, loans, and leasing arrangements – or not.
In one way or another, leasing is increasingly being used to finance IT. "Our users have traditionally bought their own hardware and infrastructure, and we have then put a management wrap around it," says Simon Hancock, CFO with Control Circle, a global provider of IT solutions. But over the past couple of years, the blue chip companies it manages infrastructure and data centres for have become ‘less willing to spend and more interested in leasing.’
In response, it has tweaked its business model: ‘We are working with specialist providers to facilitate the finance for customer leasing, or acquiring assets ourselves and then leasing them to customers.’
Control Circle has worked with Lombard Finance to do this, but there are lots of specialist providers of leasing finance for hardware and for software licenses – as Google can quickly reveal – and these can be accessed directly (by IT buyers) and indirectly (through service providers).
But leasing is a complicated area. There are operating leases, finance leases, balloon leases, and arrangements such as sale and lease back, and lease purchase, and you are as likely to encounter some of these when you are financing cloud computing as when financing access to traditional computing resources. Even before we get into the accounting technicalities (on which more later), we must wade through some murky waters.
A finance lease has a finite length (of one year, or three years and so on) and the amount paid during that period covers the full value of the asset plus finance charges – which may include a lump sum ‘balloon’ payment at the end of the lease. Although legal ownership does not pass to you (as the lessee) until at least the end of the agreement, you are responsible for maintaining and insuring the asset and it will appear on your balance sheet as capital item.
At the end of the lease period, you have various options, such as extending the lease or selling the asset, though the range of options will depend on your agreement with the finance company. In some cases, the proceeds of any sale may be split between the lessee and the finance company, in others 100 per cent of the proceeds may remain with the lessee – and all of these possible permutations have implications for tax, statutory financial reporting, and overall cost.
Operating leases are more flexible. They are available for long and for shorter and periods of time, and because the leasing company leases the equipment anticipating that it will be leased again at the end of the lease, or sold, this is built into the cost. It can be easier to link this type of lease to IT strategy and refresh cycles. Assets financed this way do not show up on the balance sheet, and the entire operating lease cost is treated as a cost in the profit and loss account.
Lease purchase enables you to pay a deposit, and then repay the remaining balance over an agreed period, with or without some of the cost deferred and paid as a lump sum (balloon payment) at the end of the period covered by the agreement. Sale and leaseback can be used to access capital that might otherwise be tied up in your equipment, as you can sell hardware to a specialist finance company, and then lease it back for the remainder of an agreed term.
The details can be potentially mid-boggling when it comes accounting treatments, tax, and financial reporting, so it’s a good idea to get an accountant involved in the decision-making process. They don’t get paid the big bucks for nothing – any more than IT professionals do. But even if you don’t want to get too bogged down in the accounting technicalities, you can’t avoid wading through some rather murky waters.
SaaS providers muddy them, because some offer access to software in the cloud via rental and others offer lease access, and the differences can be hard to spot. Leasing generally involves a contractual commitment of between one year and five years (though some short term operational leases can run for just months), and while some rental arrangements can be terminated with one month’s notice, others require a commitment of at least one year.
Things become even more opaque when you consider the many combinations of hosting, leasing, buy and lease-back, rental, and ownership (of software licences and hardware), that you find variously grouped under the headings of hybrid clouds, private clouds, and even the public clouds. But when you are making a decision about which approach to take to accessing IT, and paying for this, it is important to be aware of the devil in the detail, and the associated financial implications.
Each scenario must be examined individually. Accountants need to consider myriad factors ranging from national accounting rules to policies for capitalisation thresholds. They may want to check contracts to see, for example, if the cost of access to software, services and hardware are separated from the associated support and maintenance (or not), and assess the financial implications – total cost of ownership is an issue and some approaches are more effective from a tax point of view.
Many seasoned IT professionals may find their heart sinking at the prospect of inviting accountants into the decision-making processes. But by working together they can get the services that the IT department needs, when it needs it, without spending more than necessary on it. "In many organisations, the CFO and CIO already work together to finance IT," says Bill Sinnett, director of research at the Financial Executives Research Foundation (FERF), yet they could do more.
"There is an opportunity for them to form a powerful alliance,’ he suggests, and not just in organisations big enough to boast CFOs and CIOs. As decisions about which software and hardware to spend money on are moving away from IT experts, into the hands of departmental budget holders and individuals, finance and IT professionals can unite to provide the necessary structure and control. So now might be a good time to overcome some of that Pavlovian conditioning and play nicely together.
