When looking at software and services, a big reason why companies switch to cloud services from on-premise servers is, among other things, the cost savings involved. However, a common refrain that is being told more and more is that cloud services may not be the solution for more established companies as the cloud subscription model become increasingly expensive. In my experience, CTO’s and CFO’s love the idea of paying rent for resources such as cloud services because it offers greater flexibility and easier expansion. Unfortunately, a mature company isn’t always looking for these attributes for their technology needs. So what is the solution for these companies? The answer may depend on the company’s current accounting priorities and its current stage of growth.
From a cost perspective, a company that has dedicated private, on-premise servers has to deal with the overhead of owning IT staff, fail-safe procedures, server rooms, air-conditioning and, above all, the very expensive dedicated servers. Beyond the obvious HR costs and the disadvantage of having only one location for these servers, a company also has to be aware of these decisions on its ledger. As a company makes the decision to move from private servers to the cloud, the cost of those services is converted from a capital expense (e.g. fixed assets, like buildings and equipment) to an operating expense (e.g. normal business operations). The shift in reporting changes the metrics and the motivation when it comes to writing off expenses.
As a company enters specific stages of growth, it looks to shift expenses to different parts of its ledger. Small companies and those that want to stay private want to write off their expenses immediately while larger companies and those that are public opt for longer amortization cycles. In this context, the company must understand how accounting principles take effect. Capital expenses, such as private servers, depreciate over time and this depreciation is, typically, amortized over 5 years. So if $200,000 is spent on a private server, a company cannot take an immediate $200,000 charge against the Year 1 income but must spread that cost out over 5 years (a capital expenditure of $40,000 per year). On the other hand, the money that is spent on a cloud service provider comes straight out of Year 1 income. So if $100,000 is spent on a cloud service provider, the company must show an operating expense of $100,000 against the Year 1 income.
Thus, the question for the business from accounting perspective becomes – should we opt for a cloud service to take a higher, immediate write-off or do we opt for a private server to spread our expenses out over a few years to make profitability look good. It’s an important question to answer because the outcome is based on productivity just as must as profit. In the end, comparing purchase price from an accounting perspective is an often overlooked part of the private server vs. public cloud debate even though it should not be.