Cloud computing casts a shadow on costing

1 Dec 16

Cloud computing is shifting expenditure on technology from capital to revenue. Are financing concerns blurring its benefits?

Cloud computing is shifting expenditure on technology from capital to revenue. Are financing concerns blurring its benefits?

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Cloud computing is revolutionising IT provision in public services. It promises to radically reduce costs through economies of scale and greater flexibility, with some organisations claiming to have saved 30% or more from its adoption. 

It is not surprising therefore that many public sector bodies are moving away from having their own data centres and their IT decisions are increasingly about ‘sourcing’ and the integration of cloud-based software. It is also why the UK government has adopted a ‘cloud first’ policy since 2013. At the same time, more and more software suppliers are moving their applications to the cloud as it is easier to deploy, sell and maintain cloud solutions, with the expectation that by 2020 almost all organisations will be predominately using cloud technologies.

Cloud computing can, however, create problems for finance teams as it means that software and technology are purchased ‘as a service’, with expenditure potentially moving from capital to revenue. Plus, where charges are based on use, there may be less certainty over future costs. There may also be VAT implications. 

The use of cloud computing can bring new ways of working. This may include business process re-engineering, testing, training and data migration, as well as functionality and integration with other software. Costs arise from these activities, which can be performed by the provider, the customer’s staff or third parties. They may include administration, overheads, future upgrades and enhancements, as well as payment plans to smooth out large upfront costs or initial discounts. You begin to see the difficulties? Are these capital or revenue, and does it matter?

While capital expenditure will ultimately feed into financing costs, the direct charge to the revenue account arising from service based contracts can be seen more explicitly as a call on scarce resources; an issue that is particularly pertinent when future revenue streams are subject to additional scrutiny.

An organisation that, for example, avoided £8.4m of expenditure on new data centres by migrating more than 100 applications to the cloud – which would also address ageing systems and put in place more robust, cheaper disaster recovery and back-up – could easily point to capital savings and service benefits but struggle to justify the increase in revenue expenditure. 

The restraint on public finances puts enormous pressure on revenue budgets and can lead to short term decision making. Existing systems can, for example, include significant sunk costs leading to a focus on marginal rather than full life costs, making business cases and comparison difficult. Also, the move to greater compliance with internationally recognised accounting best practice, set against a funding system with a distinction between capital and revenue resources, can create artificial barriers to the comparison of capital and revenue intensive projects. 

Is the transition to the cloud causing difficulties for your finance team? 

 • CIPFA consultation, Accounting for the Cloud, is examining these issues and potential difficulties. See 

  • John Thornton
    John Thornton

    John Thornton is the Director of e-ssential Resources and an independent adviser on business transformation, financial management and innovation.

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