Why State Government Finance Is Pivoting to the Cloud

State governments collectively spent $2.9 trillion last year, an increase of 7.3% over the previous year, according to estimates by the National Association of State Budget Officers (NASBO). Over this same period, the federal government sent more than $800 billion in pandemic aid to the states. And, in the years ahead, some of the $369 billion from the Inflation Reduction Act will also go to states for clean energy and climate investments. 

With so much money to manage, state governments need modern finance technology that helps them track people and results, allocate funding, and stay agile.  

Financial systems are supposed to be the program management, resource allocation, and accountability backbone for state spending, revenue, and borrowing. Yet, many state governments use systems that are 25 to 30 years old and struggle to deliver efficient transaction processing, let alone adequate decision support. 

As a result, many states are now ready to pivot to a new generation of cloud-based software that promises to digitally transform financial management.

Based in part on a panel discussion organized by Workday at the Annual Conference of the National Association of State Auditors, Comptrollers, and Treasurers (NASACT), this article focuses on four questions: 

1. What is the state of the market for financial systems?

2. What are the unique aspects of state government finance?

3. What motivated early mover states to embrace finance modernization? 

4. Where is state finance headed in the future with the rapid advances in technology such as cloud, artificial intelligence (AI), and machine learning (ML)?

What Is the State of the Market for Financial Systems?

With all the other demands on state governments, why prioritize financial system modernization?  

Even the most functional legacy financial systems in state government are heavily customized, inflexible, limited in data capture, and overly focused on the needs of central finance, with departmental needs sometimes taking a back seat. They also rely heavily on central IT support and are propped up by a legion of shadow systems to address gaps. The result is a cyber-risk-laden, costly IT environment that eats through budgets that would be better directed to constituent services. 

The oldest of these financial systems rely on proprietary languages requiring extensive recoding to keep pace with regulatory and compliance changes, at a time when skilled programmers are in short supply. And with the challenge of recruiting the next generation of talent to work with green-screen mainframe interfaces or client/server technology, it’s hard to dispute that the time to modernize financial systems is now.

State governments have several decision factors to consider when modernizing enterprise resource planning (ERP) in the cloud.

Range of Industries Served

Should the state partner with a software company focused solely on the government industry or one that also serves a broad range of other industries? 

While there may be advantages to teaming with companies that only serve governments, the reality is that these companies have a much smaller customer and user base. They are unlikely to have the research and development (R&D) budgets for continuous innovation or to keep pace with rapid advances in technology. 

In fiscal year 2023, Workday reinvested 37% of our total revenue into R&D—among the highest in the ERP industry. Workday’s $2.3 billion investment in R&D is hard to match for a company focused solely on government. Without the requisite R&D, a state’s new ERP system will quickly become its next legacy system.

User-Centric Design

Some software companies pride themselves on their staying power in the state government market. A long track record serving states is a good thing but it’s not everything. 

Some of the most innovative companies today, such as Amazon, Apple, Google, Meta, Netflix, and Tesla, weren’t around in the 1970s. Their big advantage was to conceptualize products and services from a clean sheet, putting user experience at the center of product design. This is also one of our biggest advantages: Workday software is built from scratch for the cloud. It delivers a consumer-grade user experience and is intrinsically architected to keep pace with technological advances. 

By contrast, legacy vendors are often hamstrung by prior concepts, designs, and processes that are difficult to shed when there is a paradigm shift in technology. For legacy ERP software companies, it’s often just too complex and expensive to redesign from scratch. 

Modernization Scope

Should states modernize their full platform—human capital management (HCM) and finance—or just one of the pillars—either HCM/payroll or finance?

For the most part, states have chosen to modernize the HCM pillar first, including Workday state government customers such as Iowa, Maine, Maryland, Nebraska, Oklahoma, and Oregon. The tight labor market and need for remote or hybrid work put pressure on states to overhaul the job-candidate experience, improve retention, and foster employee engagement, leading in part to prioritizing HCM over finance. What job applicant wants to work for an employer that requires numerous paper forms to be filled with their personal information? 

There are states that have decided to modernize their entire platform on Workday, including Georgia, Rhode Island, Vermont, and Washington. To date, across the leading ERP products, there are far fewer states that are “live” running finance systems in the cloud compared to HCM. Approximately 15 of the 50 states have either just completed or only recently started their finance modernization journeys.

True Cloud vs. Limited Cloud

Another decision involves whether to modernize using a true cloud strategy or a limited cloud approach. A true cloud ERP has features such as multi-tenancy, cloud-native architecture, robust security, and periodic upgrades that do not disrupt customer operations. By contrast, a limited cloud modernization retains the legacy system largely as is and migrates it to a managed services provider’s data center (i.e., hosting and managed services only). While some legacy vendors still market limited cloud as a “cloud migration,” clearly not all cloud journeys are equal. 

The true cloud approach using a product such as Workday might require greater initial investment, but the outcome is a digital transformation platform that delivers new product functionality, a superior user experience, best practice business processes, improved security, robust reporting, AI, ML, and analytics technologies, a predictable cost model, and a litany of other benefits. At best, the limited cloud approach delivers marginal cost reductions through economies of scale in sharing infrastructure and shifting some of the support burden off the IT department. 

Caveat emptor: If a software company states that their on-premise and cloud versions deliver essentially the same functionality, what governments are likely buying is stale underlying software hosted in a commercial data center. To summarize, the trend for states to migrate finance to the cloud has only just begun. By my estimation, nearly 70% of the state government market remains for financial system cloud modernization.

Niche Software Functionality

What functionality do the leading cloud ERP companies deliver themselves versus relying on partner software companies? 

It’s important to understand that no software vendor does it all. Areas such as facilities, fleet, enterprise asset management, permitting, sales tax systems, and marketplaces/catalogs supporting procurement are all examples of functionality that ERP cloud providers often rely on their alliance software partners to provide. What’s important is not that a solution such as Workday does it all, but that our technology architecture can seamlessly interface with partner software products, with standard APIs being readily available for the most prominent, specialized applications.

Critical Finance Capabilities: What Are the Unique Aspects of State Government Finance? 

From one vantage point, the basic financial management needs of state governments aren’t all that different from commercial entities. States need to manage budgets, account for revenues and expenditures, pay their bills, track receivables, record and depreciate assets, manage capital projects, report financial results, and more. 

However, there are unique state government requirements that many commercial entities don’t have. Some requirements stem from past practice, legislative mandates, regulatory compliance, or grant requirements. Figure 1 outlines some of the complexities in state government finance.

For generally accepted accounting principles (GAAP) compliance, state governments must adhere to Government Accounting Standards Board (GASB) pronouncements related to modified accrual and/or accrual basis of accounting depending on the type of reporting required (e.g., fund level vs. governmentwide statements). In addition to GAAP, some states require their accounting records be maintained on a cash, modified cash, or an alternative statutory basis of accounting. As such, cloud financial systems need to deliver multi-bases of accounting, especially for financial reporting to different stakeholders. 

Some states have statutory mandates that do not permit expenditures that exceed the revenue collected in that fiscal year, regardless of the state government’s cash balance. Moreover, certain states may require an “advanced cash balance check” for some fund types both when a purchase order is executed and again before the invoice is paid.

Facilitating labor cost distribution from payroll to financial system components, such as projects or grants, is critical for accurate costing and reporting. Nearly all state governments struggle with this due to their legacy financial systems. 

What’s important isn’t the peculiarity of state finance practice, but the flexibility of the financial system to adapt to these requirements. GASB will continue to improve and evolve the financial accounting and reporting model. 

Workday prides ourself on delivering solutions architected with adaptability in mind to anticipate change. Our approach to upgrades and continuous innovation helps ensure that our financial systems are “obsolescence-proof”—a major leap given that many states now find themselves stuck with outdated legacy systems.

What Motivated Early Mover States to Embrace Finance Modernization? 

At our NASACT panel, we heard from the state of Washington, which is among the first-mover states pursuing finance transformation using a true cloud strategy. 

State of Washington

The state of Washington has approximately 110 agencies, 68,000 employees, and annual expenditures of $81 billion. Washington currently runs a financial system that relies on 1960s era technology. In the executive order that established the One Washington project, the state outlined some of its motivations to modernize finance, HCM, and procurement in the cloud. Cyber threats, failure potential of system components, fragmentation of applications and processes, and the challenge of maintaining decades-old technology were some of the motivations for change. In seeking to migrate 220 agency systems to Workday, One Washington is among the most ambitious finance transformation projects across state governments.

Washington aspires to standardize the chart of accounts, implement best-practice business processes, utilize workflow, improve audit trails, gain access to data analytics, and achieve integration between finance sub-functions (and between finance and HR/payroll). 

On chart of accounts redesign, Mike Schaub, One Washington’s project leader, noted, “We don’t currently have a chart where agencies use an element in the same way, which makes reporting on expenditure categories across the state a challenge. Workday will address this issue.” One Washington also seeks to deliver an intuitive user experience. Core elements of the financial system are expected to be in production by late 2025. 

Where Is State Finance Headed in the Future With the Rapid Advances in Technology Such As Cloud, AI, and ML?

Rapid advances in AI- and ML-driven automation and analytics ensures that finance and accounting work today won’t look the same in the future. 

AI and ML rely heavily on prediction using statistical models. Good models require more and higher quality data; predictions get better with experience. Finishing up 2023 with 65 million users, 629 billion transactions, and 5,000 core finance and HCM customers, Workday is well positioned to capitalize on advances in AI and ML as we collaborate with customers to promote data-driven enterprises.

The likely impact of AI and ML on the state government workforce isn’t fully known, but certain trends are telling. Today, most central and departmental finance staff dedicate the bulk of their time to transaction processing and data collection. Less time is dedicated to reporting and compliance, and an even smaller amount to analytics and insight. Figure 2 shows how this pyramid will be inverted as AI- and ML-driven automation and analytics take hold.

A true cloud application such as Workday is already leveraging AI and ML in its core platform and has been for many years. Touchless accounting transactions, journal entry anomaly detection, invoice matching recommendations, automated bank statement reconciliations, duplicate expense detection, and proactive spend management are just a sample of the finance areas where manual work will be eliminated, providing finance staff greater capacity. 

AI and ML technology advances come at an opportune time given that the American Institute of Certified Public Accountants (AICPA) “2021 Trends Report” found that 75% of the certified public accountant (CPA) workforce met retirement age in 2020. There was also a 36% drop in CPA exam candidates compared to 10 years ago. 

For the future of state finance, technology-enabled innovations will eliminate the mundane, lead to more rewarding jobs, and drive greater efficiency in business processes.

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Thanks to Kelly Dudley (state of Georgia), Mike Schaub (state of Washington), and Rob Zwieback (Workday) for serving on the 2023 NASACT Annual Conference panel “State Government Finance in the Cloud.” I would also like to thank Ray Baez (Accenture) for conversations and insights on state government finance.