A type of cost-benefit analysis to identify at what point (if ever) benefits equal costs.
SummaryA cost-benefit analysis is a process that helps you determine the economic benefit of a decision, so you can decide whether it’s worth pursuing. It’s a useful tool when you want to avoid bias in your decision-making process—especially when you’re faced with a big decision that will impact your team or project success. Cost-benefit analyses can seem daunting at first, but don’t fret—we’ve simplified the process into five concrete steps. Show
In 1848, a French engineer named Jules Dupuit was working on a bridge. As an amateur economist, he decided to run an experiment to answer this question: How much should the government charge for tolls to cover building and maintenance costs? This may sound simple, but Dupuit threw in a curveball—when considering net costs, he subtracted the social benefit the bridge would bring. Calculating the social benefit of a bridge sounds like a puzzler, but not for Dupuit. He just measured how much people were willing to pay to use it. Then with some fancy calculations, he was able to recommend a toll amount that took into account the costs and benefits of his bridge. And so, the cost-benefit analysis was born. The process has been refined since Dupuit’s day, and now it’s used less for calculating bridge tolls and more for figuring out if decisions are economically feasible. But the big picture remains the same—when it comes to decision-making, costs and benefits are key. What is a cost-benefit analysis (CBA)?A cost-benefit analysis (also called a benefit-cost analysis) is a decision-making tool that helps you choose which actions are worth pursuing. It provides a quantitative view of an issue, so you can make decisions based on evidence rather than opinion or bias. During your analysis, you assign monetary values to the costs and benefits of a decision—then subtract costs from benefits to determine net gains. This helps you estimate the full economic benefit (or lack thereof) of your choice so you can decide if it’s a good idea to pursue. Create a cost benefit analysis template When should you use a cost-benefit analysis?A cost-benefit analysis works best when you want to decide whether to pursue a specific course of action. It also helps when your decision has clear economic costs and benefits. For example, it’s easier to create a CBA to determine the feasibility of a new project than to evaluate whether a new hire would be a good fit for your team. That’s because it’s hard to assign concrete financial costs and benefits to someone’s experience and work potential. This type of economic analysis also takes some time to complete, so it’s best for when you’re faced with a big decision that will impact your team or project success. For smaller or less complex decisions, try using a simpler process like a decision matrix. Here are some examples of when to use a cost-benefit analysis:
5 steps to creating a cost-benefit analysisCreating a cost-benefit analysis may seem daunting at first, but we’ve simplified the methodology into five concrete steps. After you’ve run through this process once, you can tailor these steps to suit your specific project or team needs. 1. Build a frameworkFirst, create a framework that lays out the goals of your analysis, your current situation, and the scope of what your analysis will include. Your framework should include these components: The question your analysis will answerA successful CBA always starts with a good question. It helps to be as specific as possible—for example, it’s easier to answer “Should we improve our mobile app?” than a broader question like “What products should we improve to drive adoption?” An overview of your current situationAn overview provides context for your analysis. It gives you a starting point to work from, so everyone understands where you’re coming from and why you’re considering a change. Here’s what to include in your overview:
For example, imagine you’re trying to decide whether to overhaul your mobile app. Here’s what your overview might look like:
The scope of your analysisFinally, your framework should include the scope of your CBA. Like a project scope, this creates boundaries for your analysis and lays out what type of information you’ll consider in your calculations (plus what you won’t consider). Typically, your scope includes:
2. List and categorize costs and benefitsNext, it’s time to list all the costs and benefits of your decision. For this step, it’s helpful to collaborate with stakeholders so you can benefit from their specific expertise (for example, your IT team would be able to estimate how much new software would cost). Think of your decision like a project you’ll complete to achieve your proposed course of action. Ask yourself what resources you need (like materials or labor), and what the results of your decision will be (like additional revenue). As you list out costs and benefits, sort them into the following categories. Then in the next step, you’ll estimate dollar amounts of each of these items. Types of costs
When listing out tangible costs (like direct and indirect costs), follow the same process you would when creating a project budget. Think of all the tasks you need to complete to follow through on your decision, then list out the resources required for each deliverable. For intangible costs, you’ll have to use a bit more creativity. If you’re stuck, try looking at similar projects that have been completed in the past to see what type of impact they had. Types of benefits
3. Estimate valuesNow it’s time to estimate the value of each cost and benefit you’ve listed. This is most straightforward for tangible categories you can assign a specific dollar amount to—like direct costs, indirect costs, and direct benefits. For intangible categories like intangible costs and indirect benefits, assign KPIs in lieu of dollar amounts. For example, you could measure customer satisfaction by tracking customer churn rate (the rate at which customers stop using your service). If you can, use the same KPIs for both costs and benefits so you can easily compare them later. We can’t predict the future, so these are ultimately just estimates. To make your calculations as accurate as possible, try comparing costs and benefits from similar projects you’ve completed in the past. Old projects are a gold mine of historical data and lessons learned. They can help you see the real-life economic value of past costs and benefits—plus any items or circumstances you might have overlooked. Using a project management tool can make this step easy—since all of your project information and communications are housed in one place, you can easily look back at past initiatives. Create a cost benefit analysis template 4. Analyze costs vs. benefitsNow comes the fun part—the actual analysis of your costs and benefits. Before you get started, here are some key terms to keep in mind:
These are a lot of fancy terms, but don’t let that scare you. If you don’t want to include more complex calculations like net present value, benefit-cost ratio, discount rates, and sensitivity analysis, you don’t have to. To keep things simple, you can just calculate your net cost-benefit and leave it at that. If you used KPIs to measure intangible costs and benefits, you can compare those separately. To analyze KPIs, there are a couple different approaches:
5. Make recommendationsNow that you’ve completed your cost-benefit analysis (huzzah!), you can make a recommendation. Here are some factors to consider for your decision:
Cost-benefit analysis limitationsCost-benefit analysis is a handy tool for data-driven decision making. But like any estimation technique, it isn’t perfect. When deciding whether to use a cost-benefit analysis or another decision-making process, keep in mind these limitations:
If you decide that a cost-benefit analysis isn’t the right fit for your particular situation, you may want to consider creating a decision matrix or decision tree analysis instead. Make decisions countA cost-benefit analysis helps you use data to make the best possible decision. That means you can say goodbye to coin flips and choose your options with confidence. Creating a cost-benefit analysis can seem like a project in its own right, especially if you’re working with multiple stakeholders to get the job done. Before you dive in, consider using a project management tool to coordinate work. Asana lets you create and assign tasks, organize work, and communicate with stakeholders directly where work happens. You can also map out your entire cost-benefit analysis project and save it as a template for future use. Create a cost benefit analysis template What are the types of costSeveral techniques are available, with the most common being the payback period, net present value, and rate of return.
What are the three types of cost in costAs mentioned supra, a cost-benefit analysis is generally based on three decisive indicators: (i) the net present value (NPV), economic rate of return (ERR) and the benefit-cost ratio. Each of these three indicators assesses the viability of the project and combined they provide a realistic picture of the IPF.
What are the 4 steps of costCost-Benefit Analysis in Project Management
From that, you can calculate the cost-benefit ratio (CBR), return on investment (ROI), internal rate of return (IRR), net present value (NPV) and the payback period (PBP).
How can you identify benefit/cost analysis?Steps of a Cost-Benefit Analysis. Establish a Framework for Your Analysis. ... . Identify Your Costs and Benefits. ... . Assign a Dollar Amount or Value to Each Cost and Benefit. ... . Tally the Total Value of Benefits and Costs and Compare.. |