Opex and Capex: what’s the difference for IT budgets?

Driven by digital transformation and the digitization of business activities, IT issues are becoming increasingly important for companies. To meet these challenges, the IT budget often plays a substantial role, sometimes involving substantial investment. It’s easy to see why the accounting of IT expenditure is closely scrutinized in balance sheets. Opex or Capex, the impact on the company’s results is not neutral, even as business models are undergoing radical change. How should CIOs tackle these issues? What strategy should they adopt? Here are some answers.

What are Opex and Capex?

Let’s start with a few definitions. Opex and Capex are not concepts specific to CIOs. They are 2 accounting concepts essential to the financial management of all companies, whatever the management budget concerned.

Opex vs Capex, why is this such an important issue?

On the face of it, the management of Opex and Capex is fundamentally not the responsibility of the CIO. This categorization of expenditure should not play a part in the orientation of his purchasing decisions, for which only technical, operational or value-added considerations should take precedence. The CIO could therefore be content to manage a budget of commitments. And yet, in his position as director, a stakeholder in his company’s strategy and results, the financial impact must be taken into consideration.

From the point of view of the finance department, however, expectations are quite different. Whether or not a certain number of IT expenses can be capitalized will determine whether or not the income statement can be maximized. Positive results, cash flow requirements, cost structure, etc. From the CFO’s point of view, the balance between Opex and Capex is closely analyzed, for all the company’s expenditure items, and particularly for IT expenditure, because of the weight it represents.

Capex/Opex: how should the CIO position himself?

In the IT department’s budget, the subject of Capex-Opex trade-offs is complex and not systematically mastered. In many cases, it is even totally transparent to the CIO, who is only asked to manage a commitment budget ( the famous “cash out” view, see below). The distinction between Opex and Capex is the sole responsibility of the Finance Department, depending on the degree of commitment to a capital expenditure policy. The CIO may be involved in identifying capital expenditure, but not in quantifying its impact.

At a more advanced level, the IT department is sometimes involved in Opex/Capex management. Often, it is given a “macro” framework with a P&L budget target (including Opex and depreciation), which requires it to respect an overall balance for its entire IT budget.

To comply with this, the CIO must be able to identify which costs are Opex (operating expenditure) and which are Capex (capital expenditure). To do this, he or she needs to determine the precise category and nature of each purchase, monitor its evolution and report on it. Does the purchase of new software take the form of licenses or subscriptions? Is hosting internalized, with purchase of equipment, or outsourced to a hosting provider? This precise breakdown can only be done if you have the right budget analysis keys, and efficient, easy-to-use management tools that enable you to cross-reference and reconsolidate the whole picture.

However, this second approach could be too much of a stretch to confine the CIO to the role of executor of budgetary instructions from the CFO. It is neither sufficient nor satisfactory in the age of agility, and the CIO would do well to take a closer interest in the Opex/Capex issue, in order to strengthen the quality of his dialogue with the CFO and position his department as a genuine value center.

How can it do this?

1- Explain market trends

The market has evolved considerably in recent years. The emergence and development of Cloud and SaaS models, and more generally of all ” as a service ” approaches, have gradually supplanted the old ways of doing things and managing IT expenditure:

• Nowadays, outsourced cloud hosting services are rented rather than investing in servers or infrastructures of their own.
• Subscribing to software “ as a service ” rather than investing in licenses
• There may be a tendency to outsource to a service center rather than recruit internally, and so on.

As already mentioned, the CIO’s choices must be guided first and foremost by IT efficiency considerations, not financial ones. Switching a previously ” on premise ” application to Saas(Software as a service) mode, or starting a project to move to the cloud, must be primarily driven by operational, not accounting, objectives.

On the other hand, when it comes to these changes, CIOs are the “knowers”; it’s up to them to detect these fairly inescapable market trends as soon as possible, and toexplain to their CFO contacts, in a pedagogical way, how the consequences can be win-win for their department’s operational efficiency, as well as for the company’s finances.

2- Discussing value creation

Admittedly, the emergence of cloud models and “ as a service ” software has gradually reversed the Capex/Opex ratio on IT spending. But they are not necessarily a bad calculation, and offer many advantages in terms of adding value to the IT department’s budget: with subscription logics, CIOs gain considerably in flexibility and agility, with much more flexible management of their budget as it is more easily oriented to usage. It’s a safe bet that CFOs will be receptive to these arguments, which enable them to order and spend only what’s strictly necessary, to react quickly to changing needs, to benefit from new features without waiting, and so on.

In this context, the quality of the dialogue between the CFO and the CIO is key. Investment or operation: by being proactive on these issues, the CIO will demonstrate that he or she is not distracted from the company’s bottom line, and from the CIO’s contribution as a value center.

3- Co-constructing solutions to contain the impact of these changes

So, in the short term, the drastic reduction in the share of Capex will have the effect of unbalancing the income statement and presenting a deteriorated picture in the eyes of the financiers. But it can also be a good calculation in terms of IT department management agility. It’s up to CIOs to take up this issue andcome up with solutions : for example, by suggesting that these transitions be planned and spread out over time, to smooth out their impact. In this way, we’re on the right track.

4- Presenting your budget to make trade-offs easier

Last but not least, the presentation and approval of the IT department’s budget. In discussions with the company’s management, it is quite common for certain budgetary decisions to be made on the basis of the Opex/Capex balance. The CIO’s knowledge and control of the financial cost of a given project is therefore far from trivial. For example, a budget line presented as “Capex” (capital expenditure) can be arbitrated positively without difficulty, because from an accounting point of view, if it is amortized over time, it will be perceived as “costing nothing”. This is a good opportunity to hone your arguments, and in any case to maintain a relevant level of dialogue with the finance department.

Take the context into account.

The breakdown between Opex/Capex expenditure is not set in stone, and must itself be arbitrated with agility by finance departments. This balance between operating and investment costs must be informed by factors both endogenous and exogenous to the company:

• As we have seen, it is closely dependent on the emergence of models that can have a direct impact on the categorization of expenditure (Saas > subscription > Opex; Cloud > rental > Opex) and on the balance between the two. In recent years, for example, the balance of IT spending has been completely reversed between Capex and Opex.
• The context in which the company operates must also be taken into account. Phases of strong transformation, oriented towards “major projects” and involving heavy investment, are particularly appropriate for fixed assets. Maximizing Capex helps to smooth out expenditure over time.
  Conversely, if the IT department’s budget is dominated by operating expenses (Run), this concern may take a back seat, as the Opex/Capex balance is then dependent on past policies and trade-offs, which run over time.
• In other cases, when budgets are under pressure, outsourcing certain services (and thus moving them from capex to Opex) can reduce internal costs, and free up team time that can be reallocated to other, more strategic projects, or projects that must remain “proprietary”.
• The macro-economic context may also come into play. It is therefore interesting for CIOs to monitor the impact of these underlying trends, which can provide them with key arguments when it comes to defending their IT budget. For example, in an inflationary environment such as the one we’ve been experiencing for the past few months, it’s possible to make the calculation of switching to subscription models, which will appear more favorable in cash terms than Capex; on the other hand, they are dependent on possible monthly or annual price changes at the hands of publishers; a subject to be kept in mind in order to make decisions with all the cards in hand.

Bonus: what budget is needed to manage Opex/Capex?

The question arises because confusion often reigns. The definition of these two budgetary views can be difficult to grasp in companies where financial strategy is not widely shared with the Business Units.

The “cash out” (or commitment) view of a budget is a cash-oriented view that corresponds to orders and invoices placed for the fiscal year. It shows all expenses, whether booked as Opex OR Capex. In this model, depreciation is not included.

In contrast, the P&L (Profit&Loss) view is an “economic” view based on the income statement. It includes Opex expenditure, depreciation and amortization, and deferred charges or provisions.

Depending on your needs and strategy, it may be worthwhile to navigate seamlessly between these two views, which do not offer the same reading keys for companies.