"Budgets are not something I agonize over any more" said one CIO contributor to some of our recent research. Many CIOs have to invest time and political capital to hone their IS budgets because the fact is that annual budgets are today's near-universal means of providing oversight, transparency and direction for most IS organizations. This particular CIO at least has got budgets right.

Got wrong and annual budgets can foster all the wrong sorts of behaviour, limit IS's room to manoeuvre and be a barrier to change. IS's financial approach, like so much in IS, evolves through a series of five stages. The trick is to pick the right one for your enterprise

Stage 1: Black box. The IS budget is a single number. Business management does not know how the budget is spent. While this approach gives centralized control — usually to the CIO and CFO — it does little to ensure that IS aligns with the business.

Stage 2: Glass box. The IS budget is more transparent. It is still a lump sum allocated as the CIO sees fit, but business management can influence IT investments because they can see the numbers.

Stage 3: Simple portfolio. The IS budget has two goals: Keep the lights on and invest in the business. The breakthrough in this stage is that budget discussions shift from "budget size" to "budget composition". This change lays the foundation for delivering business value.

Stage 4: Comprehensive portfolio. IT is viewed as an investment portfolio. This maturation generally occurs when an enterprise becomes more project-centric, and IS has stakeholders with competing priorities. Finer subdivision of the budget allows each investment type to have a different target and even a different decision-making process. The entire budget is more flexible.

Stage 5: Enterprise portfolio. IT expenditures are business expenditures. For some expenses, IS is the vendor manager and passes vendors' bills through to the business. Other expenses are handled directly by the business, with perhaps different investment rules, reporting and approval.

At all five stages, IS financial approaches need to provide three elements for financial management:

1. Oversight. From a governance perspective, financial approaches need to gauge IS progress so that the business can see misalignment and respond.

2. Transparency. From a management perspective, financial approaches need to translate IT into business language.

3. Direction. From an IS perspective, financial approaches need to provide IS with incentives and sanctions to motivate the staff toward specific targets.

The problem is, things go wrong with these approaches.

Today's oversight barrier is an insufficiently granular IS budget. While black-box (Stage 1) and glass-box (Stage 2) IT budgets give CIOs some control and flexibility, they can distort allocation. For example, one CIO noted that equipment to upgrade the infrastructure was delivered early, then used for short-term replacement; so when implementation arrived, IT had to make an emergency funding request. If the IT budget had been a single figure, or a Stage-3 simple portfolio, this repurposing of assets would have been invisible to business management.

To overcome the oversight barrier start with a portfolio approach. While black-box (Stage 1) and glass-box (Stage 2) IT budgets give CIOs some control and flexibility, they can distort resource allocation. Investments to maintain day-to-day operations suck up money that should be spent building new capacity. If the IT budget had been a single figure (or a Stage-3 simple portfolio), this repurposing of assets would have been invisible to business management and would have reduced infrastructure capacity.