Quality of Earnings and Technology Costs

When a Quality of Earnings audit identifies deferred technology, the price can be magnified many times. Are you deferring technology costs?

What are “True” Technology Costs?

True hardware and software costs should be measured by employee productivity. Begin with hardware. Keeping an old computer alive isn’t efficient.

A managed services client of mine described the “break/fix” portion of his business. This was for a customer who didn’t want to “subscribe” to managed IT services.

“We get a call that the printer isn’t working and dispatch a technician. We haven’t looked at that particular PC in eighteen months. Employees have loaded new programs. They’ve done some, but not all of the required updates. The technician performs the updates, reinstalls the printer drivers, and gets it working after about 2 hours.”

“When we invoice the tech’s time, the customer has a fit. ‘I could have bought a whole new computer for that much!’ he says.”

That’s exactly right! That’s why break/fix has become pretty much the domain of a walk-in trade for storefront technicians. Most IT companies can’t afford to do it anymore.

Indirect Technology Expense

More importantly, what did the malfunction create in indirect costs to the company? What’s the cost of the employee who was idle? What is the cost of the job that wasn’t printed? What is the cost of the boss’s time to fight over the invoice?

Let’s say for a simple illustration that an office employee’s fully loaded cost is $52,000 a year, or $1,000 a week. Buying a new PC every three years is about $500. How much time does the employee have to save to pay for the newer computer?

The answer is a bit less than 7 hours… a year. That’s 2 minutes a day. So, the real question becomes “Will a newer computer save this employee 2 minutes a day?” It may not be immediately obvious, but if the tech support company is charging five times the employee’s salary ($150 an hour,) saving even one incident over the next three years more than covers it.

Technology Costs in Quality of Earnings Audits

Technology costs have become an integral expense item for almost every business. That hasn’t escaped the notice of buyers, especially professional buyers.

You can expect a Quality of Earnings (QoE) audit to cover various areas. These include software licensing and subscriptions, hardware and equipment, and IT support and maintenance. It also includes cloud storage, telecommunications (bandwidth and redundancy,) cybersecurity, and data protection insurance.

If a company is still working with the old “If it fails, then we’ll replace it,” you can expect a substantial downgrade of enterprise value and EBITDA. Purchasing a dozen new PCs and a server could easily cost $100,000. Additional expenses include new software licenses, cloud storage, and annual costs for a bigger Internet pipe. You may also need a second broadband carrier.

Each $100,000 deducted from the EBITDA impacts the price significantly. The effect varies depending on the multiple being paid. It means 3, 4, or 5 times that amount is deducted from the price. That will get the seller’s attention, but by then it may be too late.

Technology costs for current (not cutting-edge) equipment and software are reasonable. They are money well spent both now and at the time of a sale. Expect and budget for them on a regular cycle. Deferring the expense might just be the definition of “Penny wise and pound foolish.”