IT spending is big business, and the way companies think about it may deserve new consideration.
2019 is forecast to see business revenues rise.
IT budgets will also increase or stay steady and as companies bulldoze outdated technology, they’re also safeguarding their infrastructure by investing more in a fundamental cornerstone: security. Most companies are ramping budgets so they can upgrade outdated IT infrastructure and one way to do this is Cloud based technology.
Companies want a pay as you go service much like electricity in the home, when you need to use more, you just can and you pay for it at the end of the month. Forecasting for capital expenditure when hardware fails isn’t easy and having a system in place that protects against hardware failures and cashflow outlays is becoming ever more popular.
IT professionals generally have two options when it comes to procuring new equipment, capabilities, and software: as a capital expense (CapEx) or an operating expense (OpEx).
Traditionally, IT expenses have been considered as capital expenditure (CapEx). Today, with the move to the cloud and the pay-as-you-go model, companies have the ability to stretch their budgets and are shifting their IT CapEx costs to operating expenditures (OpEx) instead.
Capex spending has pros and cons from the accounting side. If the asset’s useful life extends beyond a year, which is typical, the cost is expensed using depreciation, anywhere from 3-10 years.
On the other hand, the more money put towards capital expenditures means less free cash flow for the rest of the business, which can hinder shorter-term operations.
Operating expenses (OpEx) are the funds a company uses to run its day-to-day business. OpEx items are generally used up within the year they are purchased. Items such as printer cartridges, software, warranties and contract items such as yearly service or maintenance agreements are also purchased as OpEx items, because they are used up within a year.
Many material IT goods such as servers, machines and printers can be purchased either as a capital item or as an operating expense item. That is, you can pay cash and own the item outright as a capital expense. You can also lease the item or sign a hosting contract with a managed services provider (MSP) that provides access to the equipment as a service for a monthly cost, making the purchase an operating expense item.
Having the choice betweenCapEx and OpEx for acquiring new IT capabilities isn’t a new thing. It’s been with us in various shapes and forms for a long time. The difference today is that with new cloud hosting capabilities, using OpEx to procure IT equipment and services is easier today than it’s ever been.
Pros and Cons
Outside of their tax and payment treatments, there are several advantages and disadvantages to procuring hardware as either CapEx or OpEx items. Let’s look at an example of upgrading or purchasing a new server, and how it differs when procuring it as either a capital expense item or as an operating expense item. Here are the different items you would need to consider in either scenario.
- Approval process – CapEx items can take longer to gain approval for.
- Cash outlay upfront – For a capital purchase, all money must be paid up front. Purchasing on lease or from a MSP as an OpEx item allows you to pay as you go, on a monthly or quarterly basis. This can free up budget cash for more bottom line revenue producing projects.
- Supporting elements – Purchasing a server as a CapEx item may also require you to purchase several other items, including power supplies, maintenance, warranties. Procuring the same capability as an OpEx item under a contract will usually include all the infrastructure items that go along with your hardware, allowing you to pay for the infrastructure along with the hardware, in one regular payment.
- Using a 3rd party vendor – When purchasing hardware, you as the purchaser are responsible for all IT operations management (IT Ops) capabilities, including backups, operating system upgrades, and repairs. In a CapEx environment, you need to provide these capabilities. In a hosted OpEx environment, you can include these items in your contract, so that the provider will handle them as part of your monthly service.
- Scaling for growth – Purchasing a capital item requires a certain amount of forecasting. Hardware may be purchased on a three-year lifecycle, with the intent being to replace or upgrade the machine every three years. That means when you purchase the machine you would need to buy it with all the capabilities you believe you’ll need for a number of years into the future. With OpEx hosting, you may be able to contract for additional CPU and memory on an as needed basis, and run with lower capabilities the rest of the year, possibly reducing your costs.
- Control over your asset – In a CapEx situation, you own the hardware and have total control over its use, location, and disposition. If you are procuring a server as an operating expense item in the cloud, you are dependent on the hardware, operating system software, and maintenance the cloud provider is providing. You may have problems if your cloud provider has an outage, doesn’t have sufficient capability to meet your needs, is unable to meet your service level agreements, or goes out of business.
Changes in IT spending that favour OpEx
Traditionally there are two significant benefits of CapEx, aside from the financial positives: a company will own the product outright, so you can alter and tweak it as you need – and once owned, you don’t continue paying for it. Further, owning assets such as hardware and software may be seen as impressive.
Despite these benefits, three criticisms of CapEx continually rise up:
- High cost items require well-forecast budget estimates and longer time for approval, which can slow down the whole purpose of purchasing the equipment.
- Age is a significant aspect. Once you own the hardware or software, you’re likely stuck with it for a long time, in order to extend its return on investment.
- Estimating future capacity needs for hardware or software can be tricky and complicated.
Thanks to the wonder of the Internet, software can be more agile – and cost-effective. Instead of purchasing expensive licenses in a CapEx model, companies can shift towards SaaS options that require small, monthly subscriptions and run via internet connection. SaaS is also transparent, letting companies pay only for what they use, can help streamline cash flow over time, and there’s no long-term commitment. This flexibility is key.
SaaS is also very scalable. If you need to add many users only for a month, SaaS is still cheaper than outright owning software for that many users. Importantly, SaaS make it much easier to measure return on investment.
Choosing which one?
The good news is that choosing CapEx or OpEx is not an either-or situation. Companies need to choose what to allocate under CapEx and which to allocate to OpEx, understanding the trade-offs.
Proper forecasting can help a company invest as necessary in CapEx while accurately estimating OpEx.
Keeping in mind the pains of forecast and change, remember that the benefit of considering CapEx/OpEx for IT spending is about shifting money spending to better benefit overall business needs.