An Introduction To Cost-Benefit Analysis

Cost-benefit analysis (CBA) is a technique used to conduct an assessment of the benefits and costs anticipated with a project. When people or organisations undertake new projects, it is advisable that they use cost-benefit analysis to establish whether such projects should be embarked on or not. 

One of the ways to conduct cost-benefit analysis is by establishing a benefit to cost ratio (benefits divided by costs). For instance, if a currency such as the dollar were used, the cost-benefit ratio would tell the analyst the amount of dollars in benefits the project would receive per amount of dollars invested. If the ratio exceeds 1.0, it means the benefits would be greater than the costs. Conversely, if the ratio is less than 1.0, it means that the benefits would be less than the costs incurred.        

How the tool can be applied

Activity 1: Discuss the benefits and costs that are linked to the project and prepare a list of these. While putting into consideration the benefits and costs of the project, it is important to deliberate on its timeline in order to assess the benefits and costs over that period of time.

Activity 2: Monetise all the related costs such as the physical and human costs involved in all the stages of the project. In addition, all the costs involved after the conclusion of the project should be considered.

Activity 3: Monetise the value of the benefits. At this stage, it may be challenging to provide an accurate projection of the anticipated revenues of the project especially when some of the benefits are intangible. Discuss with stakeholders to gain insight into this.

Consider both one-off (e.g. labour, capital investments, etc.) and recurring costs (maintenance, license fees, etc.). The opportunity costs of not implementing the project should also be considered.

Activity 4: Compare the value associated with the benefits with the value associated with the costs and use the results of your analysis to decide whether the project is viable or not.

This technique involves a significant level of risk modelling, which helps in establishing the probability of positive project outcomes and the best choice of projects. In addition, the CBA may be used in other circumstances such as when establishing the viability of a capital acquisition, evaluating a change initiative, and deciding whether to recruit new team members or not, to mention a few examples.

Picture Attribution: “Value Price Puzzle Shows Worth And Cost Of Product” by Stuart Miles/