Cost Benefit Analysis: The Ultimate Guide to Cost Benefit Analysis

What is cost-benefit analysis?

It only makes sense to weigh the potential of proposed projects. You need to assess them for risk. Without the analysis, outcomes can hurt your reputation or be an unwanted expense.

The cost-benefit analysis gives you a chance to make better business decisions. Your analysis can determine if the project makes sense. Will its response generate the revenue sufficient to cover the project's expense? Should you go with a project that's more feasible financially?

The methodology simplifies complex decisions. You can find yourself managing a variety of expenses and tasks in your projects. With cost-benefit analysis, you use measurable financial metrics to compare your projects and their benefits.

You and the team factor in costs saved and revenue earned based on the pursuit of a project. You compare taking action minus those expenses linked to taking the action.

Rational comparison

It can be difficult to select a project. Management may be too predisposed to invest in a project, despite the availability of viable projects. The situation creates missed opportunities.

The major benefit of a cost-benefit analysis is the ability to cherry-pick opportunities. You're able to rank projects in order of merit and dispense with biases. The company's best interests always come forward.

How to do a cost-benefit analysis

The framework and principles of the cost-benefit analysis formula are applicable in almost any decision-making process. Here are guidelines for getting on point.

Establish your analysis framework

For an accurate analysis, set up the framework. How this works depends on the characteristics of your organization. Identify objectives and goals and what's required to consider the venture a success. Determine the metrics needed to measure and compare costs versus benefits.

Find those costs and benefits

Prepare lists that encompass projected costs and expected results. Begin with direct costs related to the development and execution of a project, product, service, or business decision. Direct costs include manufacturing, labor, materials, and inventory.

There are also indirect costs (rent, utilities), tangible costs (loss in productions elsewhere; impact on employees), and opportunity costs (lost opportunities because you go with one strategy over another).

Assign value to each cost and benefit

Going down the list, assign dollar amounts to everything. Some costs, such as direct, will be easy to assign. It may be a chore to calculate indirect or tangibles. But you can find software that helps you manage these values.

Tally and compare

Once you have costs and benefits quantified, tally everything up and compare the two lists. If benefits are higher than costs, there is an argument the project is advantageous. If it's the opposite, the team may want to reconsider the project or find less expensive ways to get it done.

Before you make the final call, take another look at the framework prepared in the first step of this cost-benefit analysis definition. Determine if the analysis hits all the goals you've identified for success.

Conclusion

Situations vary and change. So use a cost-benefit analysis to influence the credibility of a project's worth. Many companies apply one when they find ambiguity in discount rates. You can run and rerun the analysis to review the viability of the model.

MindManager is a great resource for collaboratively visualizing concepts. Our mind mapping software is a multimedia brainstorming tool for all teams and projects. It will simplify cost-analysis benefit planning.