Using capital funds for cloud or virtual infrastructure

How governments and agencies have successfully used capital funds for cloud or virtual infrastructure

This document is a summary of how IT leaders in Code for America’s peer network are using capital funds for cloud or virtual infrastructure.

Introduction

In the past, capital funds may have been used by public sector IT organizations to purchase computer hardware and other big ticket items. However, recent advances in virtualization and cloud-based technologies have created new challenges for governments that have traditionally used capital funds to pay for the purchase of computer hardware and other physical IT assets.

Identifying strategies for using capital funds to support projects that may have a virtual or cloud-based component can be an important part of a successful IT management strategy.

Here are some tips from others who have been down this road.

Understand what’s allowable

Spending authorized through government budgets can usually be broken into two general categories: operating funds and capital funds. Operating funds may be used to fund the cost of the day-to-day operations of government (e.g., the salaries and benefits of public employees). Capital funds are used to pay for the cost of physical assets and infrastructure (roads, buildings, etc.) that are often built over several years and have a usable life of several to many years.

The revenue for capital funded projects typically comes from the issuance of a short or long-term debt instrument. Capital appropriations may have a longer term than operating appropriations (which are almost always limited to a single year). They may also be limited to supporting projects that are depreciable over a specific period of time. City charters, finance department standard operating procedures, ordinances, statutes, and bond covenants may all contain provisions that limit the use of capital funds solely for paying for physical assets that have a specific schedule of depreciation over their usable life.

To successfully get approval to use capital funds for a virtual infrastructure, it is important to understand all of your potential funding sources, and their restrictions, and the types of spending needed to complete the new system. These constraints will inform how you lay out your funding proposal.

Systems, not servers

  • You may be able to define systems being built to perform a specific business function as capital assets. These systems might have a lifetime of 7 to 20 years, instead of the usual 3 year depreciation cycle of a physical server.

  • Work with the internal and/or external auditors that review your comprehensive annual financial report (CAFR) to get their approval that what you are planning is a system implementation.

Defining a project

  • Many components of an IT system are allowable under standard GAAP capitalization rules, such as hardware, software, professional services and employee labor costs and training curriculum development.

  • It may be possible to aggregate the costs of migration to a new cloud platform into a single capital project. This means it could be possible to include related business process development and documentation changes. Related up-front costs like “first year service fees” can sometimes be included too.
  • Get agreement from your financial controller that system components as well as migration costs can be treated as a capital project and that they can be pooled into a single project. This will also help to pass a minimum threshold that might be required for capital project treatment.
  • If you can’t use capital funds because of rules about borrowing for fixed, collateralized equipment, consider having a conversation with your finance department about conversion of debt service into an operational expense for the project.

Break a project into phases

  • If your single, pooled project cannot be funded in a single budget cycle, break it up into multiple phases.
  • Make sure that each phase implements an asset that delivers new business functionality instead of adding incremental functionality to an existing asset.

Sell good news

If you are migrating a legacy IT system to cloud or virtual infrastructure, you should be making significant budget savings. In general, most finance cash-flows can be changed with the right process and procedure, though the mechanism for how to accomplish this varies between jurisdictions. In some jurisdictions, you can take a budget amendment to your board with finance support. Making significant savings is a good news story that should help you achieve a budget amendment.

Communicate informally and frequently

  • Using capital funds to partly fund cloud or virtual infrastructure is still a new development, so there are still differing interpretations of what’s allowed.

  • Help finance avoid surprises. Communicate frequently with your finance and capital investment project staff so they don’t feel pressured into making a safe or conservative ruling.

  • Finding examples from other municipalities or state agencies may be helpful in selling capitalized cloud projects. Risk-averse decision makers are often reassured by the knowledge that other municipalities or agencies have successfully used a financing approach without anyone ending up in jail.

Sources


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