Why Budget Automation?

I start this issue by asking how many advantages do I get automating the budget of the company?  There are many answers, but let’s see some that have been observed over the years of experience:

• Increased Budget Control and therefore better financial results to make the right decisions at the right time.

• Increased ability to foresee risks in the immediate and medium term.

• Ability to assess and anticipate financial scenarios.

• Increased financial efficiency margins.

• Ability to better align my team. Determine their functions and focus on the real objectives of the company.

• A strategic vision aligned to financial and operational objectives of the company is observed.

• Uniqueness of the financial issues of the company. "We talk about the same."

• Etc…

Now, how do I begin to build the initiative to automate the budget?

We must look at different aspects and how these aspects help me in that determination.

Let's see what I have to do to determine the important aspects of each agent.

• Me: I represent the thrust of the initiative; I am the owner and beneficiary of the solution. I must explain as from me benefit each other agents.

• My team: must be convinced of the direct benefits that brings this initiative and offer you a reorientation of duties that allow them to have more time to analyze and less time to execute operational activities.

• Collaborating teams: every month, those teams help to financials to understand the industry movements, the hard competition and the general news about I+D. We can say Marketing, Sales, Business / Product, Risk and Compliance. All are geared to form a united team to make a single message to the shareholders of the company. Now this gear does not flow by itself, it requires effort and extra work. How to convince these teams to support and participate in this initiative? Will they benefit from new package of information in short time? Will the better understand the financial aspects of their areas? Etc. Convince them!

• IT Tem: the enormous efforts of the IT team should be directly benefited with this initiative, perhaps 50-80% reduction of work to be achieved. They will support you if you offer a work plan with reduced activities, increased efficiency, more control and less work. Remember, without their support you can hardly successfully push the proposal.

• Sponsor: the biggest beneficiary of these initiatives, the sponsor must see in these projects the ability to light the numbers that were in the shadows. Should be able to make decisions based on facts to tack or maintain the course of the company. If the sponsor is not able to achieve this, then reformulates the project.

The company's financial statements should speak for themselves, actions and turns must be appreciable finally here. The shareholder must clearly see that investment is in good hands.

Show me what you offer.

Asks the consulting firm to show you what they refer to processes automation, watch it and judge it with your team. Ask a lot of questions. Try to put your business culture in this new process and prepares a report with the results to your potential sponsor. Do not let them convince you without evidence.

Ask for an ideal team of consultants to achieve the objectives. Evaluate the ability of team to communicate. This is very important to achieve the expected results of the project.

Test what they say.

Try to emulate an activity inside the consultant demo where are involved all agents described above and estimated results with the deliverables you expect to receive and their results.

	Data Load	Process Visualization	Time	Activities	Reports
Me	N/A	All	Decrease 100%	Decrease 20%	Online
My team	Decrease 150%	All	Decrease 200%	Decrease 150%	Online and Control
Collaboration Teams	Decrease 80%	Now On	Decrease 50%	Decrease 1 day	Online and same data
IT Team	Decrease 200%	No	Decrease 120%	Decrease 3 days	Independence
Sponsor	N/A	All	10x faster decisions	Less meetings and 10x faster	Online
The Company	Decrease 5 days to close books	All	Financial Statements 10x faster	Business plan 95% accurate	Online

  

Calculates and calculates.

Analyzes the ROI of the project, asks for help to consultants. Determine with sponsor:

• How many bad decisions could have been avoided last year and translate it into money.

• How many good decisions could increase the value of bad decisions and translate into money.

• Check Compliances assessment with regulatory indicators and measure how many goals were breached and its financial impact.

• Analyze the market share of the company and calculates the impact of the next 36 months assuming you keep in the same trend. Now, calculate present value.

• Compare the budget with reality and determine the absolute variance.

• Others.

Take those figures and add it all, result must be multiply it by the opportunity cost of the company. If the company is in the Stock Exchange, take previous number and multiply with the beta of the industry and by two (annual basis) .

This result is the photo in terms of inefficency of the company in two years without your new proposal. Discuss it!.

SAAS or OnPremise?

I want to share with you a simple analysis noting differences of IT investment on SAAS and OnPremise infraestructures. Both are in the same starting conditions, i.e. capabilities HW / SW are similar and period is estimated in10 years.
In this study I have considered HW, SW, Staff, Training, COB, Upgrades, Inflation, ,consulting, training and support factors. For a more conservative analysis it has not been considered a decrease in prices due to increase in SAAS new customers expected in next 3 years nor to the entry of new competitors with new  database technologies . 

In order to obtain a valid approximation of the SAAS services we have considered a company that provides those services and calculated the approximate amount with a public tool from a web site and the other information has been taken from field experience.

We have not considered devaluations nor currency depreciations.

Example, COB = 10M, then 10% 1M must be added to your recurrent Outflow of OnPremise infrastructure (2M).

Now, total OnPremise outflow = 2M + 1M = 3M. This figure must be compared at same Time (t) with SAAS outflow to verify what the company priority due to current situation is.

As we can see, a break point is observed in year 5, when a OnPremise scenario turns out to be more expensive  assuming HW replacement . I see an onCloud investment should be studied as long term and not short term.

If you want to make a trial before long term contract of SAAS then you can estimate your COB ( continuity of Business) and take 10 % of the outflow and assign to total OnPremise contract with the aim to retire in case of having obtained a disservice in first year.

I suggest use 10% in “normal” conditions, but you can increase to 50% in social, 

Economic or other stressed conditions.

Example, COB = 10M, then 10% 1M must be added to your recurrent Outflow of OnPremise infrastructure (2M).

Now, total OnPremise outflow = 2M + 1M = 3M. This figure must be compared at same Time (t) with SAAS outflow to verify what the company priority due to current situation is.

  

We have calculated the present value of both types of investment over a period of 10 years and the result establishes that if you intend to migrate to technologies SAAS is best do it based on the consideration of evidence of 10 % of the COB and gradually decreasing of expenses incurred in  the OnPremise infrastructure. 

If we observe how the cash flows are distributed over the years and compare between them, we can check are inversely proportional, therefore we would have lower volatility in SAAS cash flow than OnPremise cash flow which is better for Finance Team.

It has also been observed that as IT costs in terms of infrastructure move faster or in other words,  paid faster ( cases of weak-currency countries ) , showing the breaking point is reached sooner, specifically in year 3 due to slower indexation of SAAS services in US$ currency than other solutions used to build infrastructure OnPremise in local currency and local inventory. 

A conclusion:  You must go to cloud the way you prefer but do it at least three years if you want to save money

(This conslusion is personal, it does not suggest at any time make or take decisions of any person or company based on it.)


Next more...

Daniel Juvinao

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IT Project Valuation, Part I

Continuing with our discussion about financial issues in technology, now we will see a practical approach for technology projects valuation.

Finance people normally think of three valuation techniques:

1. NPV (Net present value)

2. IRR (Internal rate of return)

3. Real Options

1. NPV

For this NPV calculation, you should take into account the costs relating to investment associated with the project as the cash flows received of income.

Remember, longer time --> decreases the value of money

Thus, the value of cash flows today won’t be the same value in the future.

Flows related to income are usually estimated over several years, which mean they must be discounted and converted to their present value using a discount rate appropriate to the project risk.

C_t = net cash inflow during the period t

C_o = total initial investment

r = free risk discount rate

t=number of periods

The problem with this technique is that it does not measure the scenarios that may occur during the same time the project is active.

If you don’t know which discount rate should be used in the formula, just consider the WACC rate of your company to reflect the opportunity cost.

2.    IRR (Internal rate of return)

Is the interest rate at which the NPV of all the benefits and cost cash flows from a project or investment equal zero.

So, you need to compare r, with other investment IRR that the company makes with the same duration. Notice that the IRR does not measure the absolute size of the investment or the return. This means that IRR can be applied to investments with high rates of return, even if the nominal amount of the return is very small. Be aware that the IRR does not consider cost of capital and cannot be used to compare projects with different durations.

If you find a 5% IIR in your IT project but you have other with 9% considering same duration, just choose the second choice.

3.    Real Options

A real option is a right, but not an obligation, to make an action (defer, expand, leave ...) on a real underlying asset (draft investment ...) at a specific cost.

In contrast with the traditional NPV method, this approach recognizes the ability of managers to delay, suspend or abandon a project once it has started. An investment is modeled with the equivalent of a stock call option in which the project manager has the right, but not the obligation, of buying something of value at a future date.

The concept of real options is based upon the fact that management does have the flexibility to alter decisions as further information becomes available. If future conditions are favorable, a project may be expanded to take advantage of these conditions. On the other hand, if the future is unfavorable, a project may be curtailed or even canceled as the conditions suggest and warrant. A traditional NPV analysis does not take these factors into account.

Most research related to the valuation of information technology (IT) investment projects are real options, however, has been limited to the application of the Black-Scholes (BS) formula. Other applications use an options-tree approach based on the binomial model. From my experience, the best choice.

In an IT development project, assets are not acquired instantaneously; rather, it is the result of a development project having an uncertain duration time in which the firm keeps investing at a rate that is less than or equal to a maximum investment rate. Only until the project is completed and the remaining cost (K) is zero, the firm will receive the underlying asset (V).

Developing a model for the generic IT investment project is not trivial because the time in which Cash flows start to be received is also a random variable. However, if we assume a deterministic time to start receiving the cash flows, we can easily adapt the acquisition model for this purpose.

Real options NPV = traditional NPV + real option value

A common strategy to mitigate risk in IT projects is to divide the project into smaller phases. Each phase is committed sequentially with a stage gate at the end of the phase.

This framework gives management the opportunity to review the project at the end of each phase, if finished phases are not generating business value, management may decide not to continue.

Expanding the analysis, read this paragraph from Mark Jeffery:

“Each phase therefore incorporates real option value, at the end of each phase management is actively deciding whether to continue the project, and working to leverage learning to improve results in later phases. These phases each have real option value, since at the end of a consolidation phase management has the option to fund the next phase.

An important management question is: ‘What is the optimal phase-wise deployment strategy that balances risk and return?’ We will use a real options approach to answer this question, and show that the answer depends upon the risk, or volatility, of the project and the traditional NPV of each phase.” Mark Jeffery.

I will mention an example: the implementation of any kind of information system requires one year and comprises four stages: initial preparation, construction, test and go live and will be finished in 1 year, so in 1 year we will know if the project will be successful or not.

According to the explanation in this article, we can have 3 ways to calculate the project value considering a real option to continue, cancel or wait to star the project.

Note: If you choose the formula of Black-Scholes, remember is a normal distribution assumption.

Soo, let’s start with numeric example:

Real options NPV = traditional NPV + real option value 

Real options Project = NPV project + NPV Start 1 year option value, for example here we are considering 2 possible results, successful or not successful project.

The initial investment of the project is 40.000 VEF and the benefits to be in 1 year 150.000 VEF, remember both variables changes stochastically over time as we saw in the stages.

If project is successfully implemented, The NPV of project in 1 year will be 150.000 VEF, if project is not successfully implemented the NPV in 1 year will be 30.000 considering 10% free risk interest rate.

The company wants to know the project value considering a cost of opportunity of 20% of return based on the best second opportunity to invest.

Then, we choose the cost of opportunity as our best discount rate to calculate NPV.

Conclusion: in this example is not good decision to implement the IT solution due to negative NPV considering two options.  We can consider any options as we could analyze, but depends on what requirements, assumptions and probabilities to consider in each occurrence. In this case, I recommend making a complementary analysis with Monte Carlo Simulation.

Next, what happen when we like to cancel an ongoing project??    See you next..!

Daniel juvinao

Banking: Customers View - Q&A Part II

The Bank is good performing with current Banking Core, and then what do you suggest we need to improve?

In this case, transactional Core business is good supported but is this information available to CFO, COO, CMO, CEO….?

What about information visibility to managers and when is available to make decisions?

So, from my experience, this is the order of things you need to focus in order to support Directors and Managers to conduct appropriate decisions on time:

a.       Strategy Vision (Try to understand why your company need to perform this process
b.      Financial Vision (Where  money come from and what is going to be used for)
c.       Operational Vision (Understand your macro chain processes and evaluate their pensiveness to a and b points.
d.      Risk Vision (In any step of your vision, focus in: operational risk, credit risk, market risk, free risk, franchise risk and cross border risk, translate to figures and triggers)
e.      Shareholder vision (What do they expect from their capital)
f.        Competitive vision (Understand your market share and position in your peer group)
g.       Market Vision (Understand what your company wealth is producing for market)
h.      Working Capital (Do we need a plan career, a valuable position, avoid competitor stolen, provide training on specialist matters and culture)

Once you have evaluated these eight points, you need to answer from top down way, what IT can offer for your company.

Check de following picture I do for you:

 

As you can see, try to focus yourself in the company and start to interact with peers to find an appropriate sponsor to improve numbers and performance.

How can I convince the company that actually needs to implement a solution to improve my team performance?

It’s not an easy way to convince your boss, but I suggest four points to at least he thinks about it

1.     KPI Based, use your team KPI performance and calculate how much you think can improve with a new solution
2.        Objectives Based, measure not reached objectives and probes you can reach this year with the new solution.
3.       Vision & Mission based, align your point 1 and 2 with your boss Objectives and CEO Vision into a special RFP. Include a functional rationale a business rationale, and an Overall better performance due to better deliveries to other areas.
4.        Resources Based, use a capacity plan with your current team and create a cost plan that allows you to define the need to hire external resources.

 Be prepared to defend your proposal!

How can I make a capacity plan to actually convince my boss?

You should actually think like him to start a proposal. So, to convince your boss, you need to include her experience and skills as your adviser to your proposal, next try to mix your objectives with her feedback.

Next, answer five questions to him:

1. Who
2.  How
3. When
4. Where
5. Risk & Opportunities

At this point, only you need your teams cost by hour, sizes your subordinates’ occupancy % and demonstrate they are at least 85% working.

Next, calculate how many hours do you need to do not interrupt your current service and how many labor hours you can use to continue in compliance with your current KPI.

In other words, you can work in your usual job as the new project, even without altering your current performance.

Finally, translate to numbers, hours, weeks and occupancy%