The process of splitting up a cloud bill and associating the costs to each cost center.
Resource usage that isn’t actively used by an organization. If a resource is provisioned, a cloud service provider will still charge for it—even if it isn’t used.
When a cloud resource is provisioned larger than is required, such as having too much memory or compute power, it’s considered oversized. Rightsizing is the act of changing the size of provisioned resources to one that better matches needs.
The normal or base rate paid for a cloud resource. This is the public pricing for a cloud resource.
Using Reserved Instances (RIs), Committed Use Discounts (CUDs), or commercial agreements between an organization and a cloud service provider in order to receive a lower rate for the resources used.
By reducing resource usage, either by removing a resource altogether or by rightsizing it, you can avoid paying for resources that would have incurred a charge. Note that there will be nothing in billing data that actually tracks cost avoidance; it’s often measured as a reduction in the amount of cost for the current month’s billing cycle.
By reducing the rate you pay for resources, you generate savings. Unlike usage reduction where you avoid costs, cost savings are represented in your billing data. The usage is there, but you pay a lower rate for it. Usually you can track savings in billing data, either directly by monitoring credits applied to a bill or by comparing the rate paid for a resource versus the normal public price.
When a saving is applied to billing data, you’re able to track the amount of savings you’ve generated in your cloud bill. By tracking realized savings against the efforts to generate and maintain them, you’re able to determine the overall effectiveness of your FinOps practices.
When looking at your cloud bill forecasts, you can predict the amount of savings using your existing commitments and commercial agreements. But until these savings are applied to your accounts, this is only savings potential.
By precommitting to a cloud service provider a set amount of resource usage using RIs or CUDs, you receive a reduction in the rate normally paid for those resources.
For every hour you’ve committed to a resource usage that you don’t use, that reservation goes unused, or unutilized. Another term for this is reservation vacancy.
Having a reservation with some amount of underutilization isn’t an issue as long as the discount you’re receiving is larger than the cost of the unused reservation. When the reservation is costing you more than what you would save—that is, it’s not utilized to an amount that saves you more than the cost of the reservation you call this reservation waste.
When a resource charge is discounted by a reservation, you call it covered. The usage is being covered by the reservation, and the result is a lower rate of charge.
Not all usage in the cloud is coverable with a reservation. If you have resource usage that spikes during business hours and then is removed after business hours, committing to a reservation would result in reservation wastage and wouldn’t save money. When usage would result in savings by being covered with a reservation, classify it as coverable.
Some resources are charged in decreasing rates the more you use them. (We’ll cover volume discounts and sustained use discounts in Part III of the book.) This means you’re billed different rates for resources as you use more, or for longer periods during the month. By examining your bill, you can see that some resource costs are larger than others, even for the same type of resource or an identical resource. When the rates are presented this way, they’re called unblended.
Some cloud service providers offer a blended rate in their billing data. This blended rate standardizes the rate you pay for the same type of resource by evenly distributing the charges to each resource. While some cloud service providers offer a blended rate in their detailed billing data, often the way the costs are blended is not perfectly even, or some resource costs are not blended, which can lead to confusion about the true cost of a resource
Some cloud resources and reservations come with an upfront fee. The amortized cost of a resource takes this initial payment into account and divides it out, attributing the prorated cost for each hour of billing.
Fully loaded costs
Fully loaded costs are amortized, reflect the actual discounted rates a company is paying for cloud resources, equitably factor in shared costs, and are mapped to the business’s organizational structure. In essence, they show the actual costs ofyour cloud and what’s driving it.
Expenses should be recorded in the period in which the value was received, not necessarily during the period the cloud provider invoiced them or when payment was made. The matching principle applies to the accrual basis of accounting, and is the main difference from the cash basis of accounting. In IaaS billing, this means you should expense spending using the billing data (e.g., Cost and Usage Reports in AWS, Cloud Billing Reports in GCP, Azure Billing File in Azure) rather than using the invoices from the provider.
Capitalized expense (CapEx) versus operational expense (OpEx)
When you capitalize something, it becomes an asset of the company, whether or not it gets expensed within a specific period. The test you can apply is":" if an organization writes a check to acquire something, does that acquisition benefit future periods? If it does, then it can be capitalized. If it benefits only the current period, then it’s an expense that is expended in this period with no future benefit, making it an operational expense. Capitalization causes total outlays to differ from expenses in a similar period, with the delta being that which is capitalized.
Cost of capital/WACC
Cost of capital refers to the cost to an enterprise to deploy their money toward an investment. In cloud, cost of capital is an important consideration when looking at commitments like RIs. For example, if a company borrows money at 8%, then its cost of capital is 8%. That 8% becomes the bar the company needs to exceed in its return on investment. However, this 8% example is vastly simplified. In reality, most companies have a variety of sources through which they gain access to capital. Various types of debt and equity financing may bring very different rates. When doing cost of capital calculations in such a situation, companies must use a blending of those rates, called the weighted average cost of capital (WACC). Most finance teams will know what their WACC is and must consider it when making RI purchases.
Cost of goods sold (COGS)
COGS measures how many dollars of outlay it takes to generate revenues in a specific period. If a power company is trucking coal out of storage and into the power plant, it would record the cost of the coal burned. That cost has no future benefit, so it’s going to be an expense that is directly traceable to revenue in that period, making it a COGS expense. The test of COGS is":" are they directly expensed and directly related to revenues in the same period? For a software company, the COGS would be the monthly cloud bill to operate its software, salesperson commissions, and support costs. Notably, cloud is the most variable and has the most potential for optimization. You can’t usually materially turn down your sales commissions or fire your support people, which shines a bright spotlight on optimizing your cloud spend without reducing revenue.
When COGS can become capitalized assets
There’s a potential curveball when it comes to how expenses are used. Let’s say a power company takes some of its coal and uses it to make diamonds. If it burned coal to generate power that was sold for revenue, the company accounts for the cost of the coal as COGS. But if it creates diamonds out of the coal, and those diamonds aren’t sold in the period but instead are put into storage as inventory for future periods, the cost of the coal would then be capitalized as an asset. How‐ever, as soon as those diamonds are sold, then the cost of the coal switches back to COGS during the period of the sale. How do COGS and capitalization come together in cloud? We recently saw a UK retailer that was developing a new shopping platform product and was applying these principles in an interesting way. The company accounted for the EC2 hours used during the generation of the product as a capitalized asset that wasn’t expensed in the period. It was able to do this because the product in development wasn’t generating any revenue. The retailer was using EC2 hours to create an asset that would generate revenue in future periods, much like the power company creating diamonds from coal rather than burning it for power. Once that shopping product went live, the capitalized EC2 costs began to be amortized into the relevant periods in which the product began to generate revenue. Note that the shopping platform product is not a physical asset, so it was amortized and not depreciated. In cloud, it’s common for RIs to be amortized into the period in which they are used over a one- or three-year period.
The most important metric. We do this by comparing the value created (see below) in unit time t, to the cloud expense increase/decrease in same time period. It cost us X more dollars to create Y more value for our clients this year.
Especially helpful for larger, more stable products/businesses