Tech Debt Belongs on the Balance Sheet

Many companies have a material amount of tech debt and are devoting significant resources to service it. Tech debt is currently an off-the-books liability, and it’s likely that a number of companies will be forced to close their doors over the next 10 years due to unsustainable levels of it. Accounting rules need to be updated to handle this 21st century situation. I believe tech debt should be calculated and included as a balance sheet liability so companies can be accurately evaluated by investors, creditors, customers, and ratings agencies.

Calculating tech debt:

There are several ways to calculate tech debt, and here’s one example – a company I worked for had 8 developers, and 4 of them spent their time working on tasks that were a result of tech debt. That is to say nearly 100% of their time was spent putting out fires, checking up on processes, and performing manual chores to keep things functioning. If the total cost to employ each of those 4 developers was $100,000 a year, the cost of servicing the debt is $400,000 a year.

Next we need to calculate the typical interest rate on tech debt. One approach is to assume that the time value principal of money also applies to development. If history is any guide, an hour of development will cost me more next year that it does this year. Therefore development hours are worth more to me now than next year. The average raise a software engineer sees annually is around 4%. So I’m comfortable with assigning a 4% interest rate on technical debt.

So we have a $400,000 annual cost to service our debt at 4% – meaning the total amout of debt is $10 million. In this case the company reports around $25 million worth of balance sheet liabilities – an additional $10 million liability is significant and material.

Going beyond the numbers:

The calculation above is simply considering the interest expense of servicing the debt and keeping the lights on. There are many other negative impacts that are harder to calculate, but in a majority of cases I suspect their cost exceeds the base servicing cost. Examples of these impacts are:

  • Never-ending turnover as new hires come in, see that they’ll be spending their life dealing with a mess, and take off for the hills
  • Cultural decay that results from high tech debt “setting the tone” for how development is done at the organization
  • The opportunity cost of development hours spent servicing debt instead of being invested in new revenue-generating products
  • Stakeholders suffer from the pain and expense of a low quality product
  • Increased time is required to deliver new features on top of a fragile architecture

Do you want to stop taking on new tech debt and eliminate the debt you have? Are you interested in acquiring a company and want to calculate the impact of this hidden liability? Reach out to me on LinkedIn, I can help!