Cost Benefit Analysis

Cost Benefit Analysis 

What is Cost Benefit Analysis ? 

A cost-benefit analysis is a process businesses use to analyze decisions. The business or analyst sums the benefits of a situation or action and then subtracts the costs associated with taking that action. Some consultants or analyst  also build models to assign a dollar value on intangible items, such as the benefits and costs associated with living in a certain town.

When to use  Cost Benefit Analysis ? 

You can use the technique 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

Steps to use Cost Benefit Analysis

Step One: Brainstorm Costs and Benefits 

 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. think about the lifetime of the project. What are the costs and benefits likely to be over time etc.

Step Two: Assign a Monetary Value to the Costs

Costs include the costs of physical resources needed, as well as the cost of the human effort involved in all phases of a project. Costs are often relatively easy to estimate (compared with revenues).

Step Three: Assign a Monetary Value to the Benefits

What is the impact on the environment, employee satisfaction, or health and safety? What is the monetary value of that impact?

Step Four: Compare Costs and Benefits

Compare the value of your costs to the value of your benefits, and use this analysis to decide your course of action.

Calculate your total costs and your total benefits, and compare the two values to determine whether your benefits outweigh your costs. At this stage it's important to consider the payback time, to find out how long it will take for you to reach the break even point – the point in time at which the benefits have just repaid the costs.

Disadvantage of using Cost Benefit Analysis

Does Not Account for All Variables : Performing a cost benefit analysis may lead you to believe that you know what to expect and have made a clear and informed decision, when the actual outcome depends on many variables that will unfold over time.

 

Increased Subjectivity for Intangible Costs and Benefits

 

Another disadvantage of the cost benefit analysis is the amount of subjectivity involved when identifying, quantifying, and estimating different costs and benefits. Since some costs and benefits are non-monetary in nature, such as increases in customer and employee satisfaction, they often require one to subjectively assign a monetary value for purposes of weighing the total costs compared to overall financial benefits of a particular endeavor. These subjective measures further result in an inaccurate and misleading cost benefit analysis.