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.

Here’s how a managed services client of mine described what’s commonly known as the “break/fix” portion of his business. This description 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 idle employee? What about the job that wasn’t printed? Consider also the boss’s time spent fighting 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 obvious at first. However, 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 encompass software licensing and subscriptions. It also includes hardware and equipment, IT support and maintenance, and cloud storage. Additionally, telecommunications (bandwidth and redundancy), cybersecurity, and data protection insurance are part of the audit.

If a company is still using the outdated approach, “If it fails, then we’ll replace it,” this can lead to a decline in enterprise value. You can also expect a substantial downgrade of EBITDA. A dozen new PCs and a server could easily cost $100,000. You also need to consider new software licenses and cloud storage. Additionally, annual costs for a bigger Internet pipe and a second broadband carrier must be included.

Each $100,000 deducted from the EBITDA depends on the multiple being paid. This deduction 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, and 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.”