Cost-Benefit Analysis

The Society for Benefit-Cost Analysis promotes the development and appropriate application of benefit-cost analysis to a broad range of public policy issues.

As it stems from the subtle anticipation of the benefit side over the cost side in its title (BCA instead of the classic CBA), the society aims at shedding new light on this successful, yet controversial, regulatory tool.

Cost-Benefit Analysis deciding, quantitatively, whether to go ahead (also known as Benefit-Cost Analysis)

You can use Cost-Benefit Analysis to decide whether to go ahead with a decision.

Imagine that you’ve recently taken on a new project, and your people are struggling to keep up with the increased workload.

You are therefore considering whether to hire a new team member. Clearly, the benefits of hiring a new person need to significantly outweigh the associated costs.

This is where Cost-Benefit Analysis (CBA) is useful.

Note: 

Cost-Benefit Analysis is a quick and simple technique that you can use for non-critical financial decisions. Where decisions are mission-critical, or large sums of money are involved, other approaches – such as use of Net Present Values and Internal Rates of Return – are often more appropriate.

About Cost-Benefit Analysis

Jules Dupuit, a French engineer, first introduced the concept of Cost-Benefit Analysis in the 1930s. It became popular in the 1950s as a simple way of weighing up project costs and benefits, to determine whether to go ahead with a project.

As its name suggests, Cost-Benefit Analysis involves adding up the benefits of a course of action, and then comparing these with the costs associated with it.

The results of a cost-benefit analysis are often expressed as a payback period – this is the time it takes for benefits to repay costs. Many people who use Cost-Benefit Analysis look for payback in less than a specific period – for example, three years.

You can use Cost-Benefit Analysis in a wide variety of situations. For example, when you are:

  • Deciding whether to hire new team members.
  • Evaluating a new project or change initiative.
  • Determining the feasibility of a capital purchase.

However, bear in mind that Cost-Benefit Analysis is best for making quick and simple financial decisions. More robust approaches are commonly used for more complex, business-critical or high cost decisions.

How to Use the Tool:

Follow these steps to do a Cost-Benefit Analysis.

STEP ONE: BRAINSTORM COSTS AND BENEFITS

First, take time to brainstorm all of the costs associated with the project, and make a list of these. Then, do the same for all of the benefits of the project. Can you think of any unexpected costs? And are there benefits that you may not initially have anticipated?

When you come up with the costs and benefits, think about the lifetime of the project. What are the costs and benefits likely to be over time?

Mind Tools members, click here.

Another Cross benefit Analysis = CBA example:

When it comes to goal setting or deciding on the best plan of attack, working up a cost-benefits analysis will help you decide just which route would be best for you. And a cost-benefit analysis doesn’t have to be complicated. You simply draw a line down the middle of a piece of paper to create two columns. On the left, list the benefits of achieving a given goal. On the right, list what it will cost you to get there. Once you’ve done that, you can simply add up the benefits and costs columns and see which has more, or assign weighted scores to each entry and total them at the bottom. Of course, you may not want to let this quick and easy analysis make the final decision for you. And it may sometimes be the nearest thing to a tossup. But even a simple cost-benefit analysis can give you an idea of whether a given goal is worth investigating further.

An example is a sales director who needs to decide whether to implement a new computer-based contact management and sales processing system. The sales department currently has only a few computers, and its salespeople aren’t computer savvy. Any system upgrade would require extensive employee training. The company is likely to experience a drop in sales during the transition period.

While total expenses, including equipment, installation and training costs, plus lost productivity, are estimated to be $55,800, the company’s analysis reveals the new computer system would increase sales capacity, boost efficiency and enhance customer service and retention–financial benefits the company pegs at $90,000 annually. Based on the cost-benefit estimates, the company would see a return on its investment in eight months. (Payback time: $55,800? $90,000 = 0.62 of a year.)

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