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📖Cost-Benefit Analysis

Decoding Cost-Benefit Analysis! Your guide to informed decision-making and project success. Learn what is the formula!

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Cost Benefit analysis preview image

What is a cost benefit analysis?

Cost benefit analysis or CBA is a “systematic process that businesses use to analyze which decisions to make and which not. The cost-benefit analyst sums the potential rewards expected from a situation or action and then subtracts the total costs associated with taking that action.” Investopedia

In 1848, Jules Dupuit introduced Cost-Benefit Analysis (CBA), aiming to assess the societal value of projects such as road or bridge construction, as per Wikipedia. What sets CBA apart and ensures its continued relevance over nearly two centuries is its capacity to quantify previously intangible metrics, like social profitability or broader societal benefits. The ongoing endorsement and utilization of CBA by governments underscore its efficacy as the primary method for determining the feasibility and desirability of projects and investments.

Cost benefit analysis definition

In project management, the benefits of your project can come in many different forms, therefore it is important to have the same units to measure benefits and costs (usually money).  The formula for cost benefit analysis won’t work effectively if each unit is different due to the hardship when comparing. 

Some projects, particularly those concerning regulation or compliance, may present challenges in applying this approach. Nevertheless, one potential strategy to overcome this hurdle is to consider compliance costs as a negative benefit. 

What is the formula for CBA?

The output of cost benefit analysis will show the net benefit (benefits minus cost) of a project decision.  For example:

Project 1:  Launch a new app will cost 150,000 with expected sales of 100,000 per unit (unit price = 2). The sales of benefits therefore are 200,000.  The simple calculation for CBA for this project is 200,000 monetary benefit minus 150,000 cost equals a net benefit of 50,000.

Project 2: Enhance your website by adding a basket feature and a ‘keep shopping feature’ when checking out to allow multiple products in one purchase.  The cost is 50,000 with expected increases of sales equal to 150,000 of revenue.  The simple calculation for CBA for this project is 150,000 monetary benefit minus 50,000 cost equals a net benefit of 100,000.

Based on comparison of these two metrics, a project investment board or stakeholder can easily quantify the best use of investment dollars to maximize return on their investment.

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A significant concern regarding the straightforward calculation lies in the factor of time and its influence on value. This concept revolves around the idea that money held presently holds greater value than an identical sum in the future, owing to its potential for earning. Thus, when comparing a cost (present value) against a benefit (future value), there exists a risk of generating inaccurate outcomes, thereby potentially misleading decision-making processes. This underscores the significance of calculating Net Present Value, which converts benefits in terms of money to its present-day equivalents.

What is the process for CBA?

Like any project process, there are multiple versions out there on what the steps are. Therefore it is always best to find what works for you and modify the process if needed.  Outlined below are recommended steps to ensure optimal utilization of Cost-Benefit Analysis (CBA) in your project decision-making process.

  1. Begin by defining the project, various options, as well as outlining goals and objectives

  2. Proceed to quantify costs and benefits, ensuring applicability within a CBA calculator. Note that not all benefits may be quantifiable, and certain costs may not qualify as investment funds.

  3. Standardize metrics utilized in calculations, specifying currency, units of value, and incorporating metrics like Net Present Value (NPV) as necessary.

  4. Execute relevant calculations, employing either a straightforward CBA approach or a more sophisticated NPV analysis depends on desired level of precision.

  5. Conduct sensitivity analysis to accommodate uncertainties, demonstrating how fluctuations in different variables could impact overall costs and benefits. A suggested method for presenting this information is through a best-case/worst-case analysis, which provides the range of potential outcomes under varying scenarios.

  6. Finalize business decision with the CBA outputs and actively engage stakeholders in the process of decision making.

Cost-Benefit Analysis (CBA) stands as an indispensable procedure that all organizations should incorporate into their decision-making processes. Its primary purpose is to facilitate informed decisions and ensure that investment resources are allocated to projects with the highest potential return. 

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