What is Cost-Benefit Analysis and How to do it?

Before making a crucial decision, the business owner must ensure that it is in the best interest of his business. The business project should be worth all the effort and hard work you put into it. To make a sound decision you will have to leverage business analytics and do an in-depth analysis to determine if your action will benefit your business.

Cost-benefit analysis

What is Cost-benefit Analysis?

Cost-benefit analysis is the process of estimating the benefits of a specific project or an action and subtracting the total estimated cost needed to attain it. You should look into the various matrices like revenue that will be earned or cost saved if you proceed with that specific action or the project as a whole. For example. If you’re planning to start a new production unit, you should analyze all the costs and the overall revenue that will be generated by that specific unit. By this method, you can determine the feasibility of that particular project to move forward with it. If the project won’t generate an estimated profit, it is wise to rule out that project.

Cost-benefit analysis is a data-driving decision-making process often used by businesses of all sorts. It helps to decide the best action for your business if you have multiple options or projects. If you’re launching a new product, planning for change in process, or thinking about capital investments in your business, you can use the cost-benefit analysis to make data-centric decisions before making a move. The formula for cost-benefit analysis will only work if the benefits are quantified in monetary terms, which is the same as the cost.

How to Conduct a Cost-benefit Analysis.

1. Set goals and objectives

Before you start, you should clearly define your project, what is it about, and its value. You should set goals and objectives for the project. You should have relevant data to do the analysis and a complete framework should be established for accurate results. Have a clear understanding of the purpose of the analysis and make sure both benefits and costs are mentioned in the same currency.

2. Identify the costs and benefits

You need to list out all the estimated costs and expected benefits of your specific project.

Different types of costs include-

  • Direct Cost – These are the costs that are directly related to your production. It includes labor cost, manufacturing cost, raw materials, inventory, etc.
  • Indirect Cost– These costs are not directly related to your production but are fixed expenses like rent and utilities, overhead costs from management, etc.
  • Intangible cost– These costs are often difficult to measure or quantify. Example: Reduced customer satisfaction resulting in reduced sales.
  • Opportunity cost– These mainly include alternate investments or lost benefits that arise when you chose one product or strategy over another.

Some of the benefits that need to be projected include-

  • Direct benefit– Increased revenue and sales generated for your product or action.
  • Indirect benefit– Customer retention, Brand visibility.
  • Intangible benefit– Improved employee morale and customer satisfaction.
  • Competitive benefit– Being the first mover in the industry.

3. Value the costs and benefits.

After listing out all the costs and benefits of your project you must assign a dollar amount to each of them. It will be hard to compare costs and benefits without assigning them a value. Direct cost and direct benefits can be quantified easily, whereas intangible and indirect costs and benefits are hard to quantify.

4. Compare total costs and benefits

Once you assign value to each cost and benefit, tally up both lists and compare. If the total benefits are more than the total costs, you can move forward with the project. If the total cost exceeds the total benefits you may have to reconsider the project. You should either consider alternate projects or work on reducing costs. You should also ensure that your project will attain the goals and objectives that you’ve set earlier.

Conducting a cost-benefit analysis is not an easy job. Quantifying intangible and indirect costs and benefits can be challenging. It should be done with optimum accuracy to make the right decision for your business. If you find it hard to do a cost-benefit analysis, consider hiring an analyst. A professional analyst can help you make the right decisions. Need help with cost-benefit analysis? Reach out to us anytime!

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