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March 29, 2023

What is a Cost Benefit Analysis?

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Do you doubt whether a particular solution will bring profits to your business? Do you think it is worth trying to get your project to life? Do you want to change your business, promotion, or sales tactic but don’t know how this might impact your enterprise? Many companies answer these questions through business intelligence research, e.g., after conducting a cost-benefit analysis (CBA). Let’s discuss such a study and how to perform it properly.

The definition of the cost-benefit analysis

The French engineer and economist Jules Dupuis developed the CBA system as early as the 1840s. Still, it became popular in the 1850s as a simple variant to assess the advantages and expenses of an activity to define whether the program was worth continuing.

As we can understand from the name, cost-benefit analysis involves determining the entire profits of an action program and then matching them with the expenses during implementation. Research conclusions are often published as payback calculations to understand when the gains outweigh the spending. Many choose this technique to compute the payback time in less than a certain interval, e.g., less than five years.

When to do CBA

CBA is necessary to understand whether it is worth sticking to a specific action algorithm. Such research also helps if your solution has certain economic costs and advantages. Let’s take a look at the most common situations where holding a CBA may seriously impact the success of your enterprise:

  • Hiring an additional worker: CBA will help to comprehend the strengths and weaknesses of attracting another employee, including studying the workload, optimal wages, and training interval.
  • Project management: it is more efficient to begin implementing ideas by understanding the parameter of return on investment than to manage savings intuitively.
  • Adding more functional programs: choosing a unique platform for doing business requires an excellent investment of time and money to test various platforms and make decisions. Doing a CBA lets you avoid disappointments.

You may employ cost-benefit analysis in business and everyday life, e.g., if you should decide to move and then take up a new position. In such a situation, one can match the wage rise with how much more expensive it is to live in a nearby or distant city to comprehend the decision on the expediency of life changes.

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Primary aims of cost-benefit research

Specialists do CBA to assist the enterprise in determining competitive advantages. Professionals can value intangible gains in monetary terms by assigning them dollar worth; this helps financial experts determine the break-even moment when the profits of buying or implementing a solution exceed the expenses.

In time, you should review the study’s results to define the real cost and payback compared with the forecast worth to improve the analysis procedure.

Suggest a chief marketing officer’s plan to recruit a writer to grow his client base, including the price of buying an advanced online platform and paying wages and employee incentives. Some opportunity costs and advantages of such interactions are problematic to quantify.

At the same time, the conversion rate optimization project requires great attention from the sales team to form additional profit channels; this process sometimes takes several years. In the event of an increase in trading through old channels, the significant potential is lost, although the return may come faster. The CBA will help find the plan with the highest cost benefit.

What is a Cost Benefit Analysis?

Fundamental principles of a cost-benefit research

Enterprises rely on CBA to support their decision-making because such analysis provides a comprehensive, evident-based perception without regard to other people’s opinions, policies, and prejudices. When implementing CBA, it is vital to be guided by the next principles:

  • Discounting of revenues and expenses: all gains and spending of the project must be expressed in economic terms, indicating a specific period. It is not only due to the effect of inflation but also because the savings you have today can be successfully invested, and they will earn interest and, as a result, be worth more than the dollar exchange rate five years later.
  • Defining the scope of research: it is crucial to comprehend the plan’s impact on a particular field of study, e.g., within a city, region, country, or the whole world. You should express the research results in at least one area of study.
  • Eliminate uncertainties effectively: in business, many things are always tricky to predict. The CBA aims to eliminate such delays and describe in detail the difficulties enterprises may face while introducing the idea.

Your cost-benefit study primarily relies on assumptions about future developments. The more time you try to comprehend, the less accurate your predictions will be. We recommend you do not try to look into the distant future, sticking to shorter intervals, which are computed in months, not years.

Basic advantages of CBA

Properly conducted cost-benefit analysis guarantees high indicators of predictability during idea implementation. To achieve optimal performance, company leaders must select research indicators and ensure all team participants deal with similar assumptions. Consider the main advantages of conducting such a study:

  • Easier business decision-making, e.g., about whether to implement an idea: if an entrepreneur spends a certain amount of time and money on it, he hopes it will pay off, at least in the long term.
  • Quickly define project aims and how they relate to each other: it is especially true if the program involves several parties or you plan to implement more than one idea at a particular time.
  • Efficient comparison of data from different sources allows you to use the most relevant insights to make an informed decision when planning and managing a company.

Cost-benefit analysis is an effective tool for long- and short-term development strategies. Such an examination allows experts to identify the better path to finish a project, revise their plans, and adjust to stay on schedule. It will enable managers to estimate the productivity of any operation before adopting the idea.

Limits of the cost-benefit analysis

Like any other scoring tool, CBA has certain limitations. It is critical don’t forget an adequate analysis model successfully overcomes any obstacles, including:

  • Misjudgment of the market: techniques of CBA work well in competitive markets with many sellers and customers without dominant players. But in practice, it is complicated to achieve such conditions. Given the presence of monopolies and state regulation, it is necessary to adjust market prices further.
  • Difficulty measuring intangible assets: significant effort must be made to estimate elements of activities that are not quantifiable. It will be problematic to assess customer satisfaction, but you can employ a churn rate, which is the rate at which users abandon your platform.

Despite all the gains of CBA, making decisions based on intuition is not always the wrong approach. Suppose you are confident that you know the proper direction for the firm. In that case, even if the cost-benefit analysis demonstrates that such costs may not pay off, you may implement the chosen course cautiously. At each stage, measure and estimate the parameters to change course if the spending exceeds the profits.

Techniques for conducting CBA analysis

Suppose you decide to make a cost-benefit analysis. In that situation, there are some variants of generating results, including the Net Present Value (NPV) and the Benefit-Cost Ratio (BCR) algorithm. Consider the features of utilizing each technique:

  • NPV is the distinction between the up-to-date worth of future benefits and entire prospective charges. If the indicator exceeds 0, economic justifications exist for adopting the plan.
  • BCR is the ratio of the present value of future benefits to prospective expenses. You should consider only those ideas for which this ratio is more than 1. The specialist should choose the concept with an enormous ratio when using this technique.

One of the described cost-benefit analysis paths may not provide an unambiguous result. Providing both categories of analysis simultaneously may be the most appropriate solution, as the company’s management can make an informed decision considering different points of view.

Main stages of CBA

At first, a cost-benefit study seems daunting, but we have simplified the algorithm to five objectives. Once you’ve done your research, you can tailor these stages to meet the needs of a particular plan or enterprise.

Select a basis for exploration

To make the research as exact as possible, you should set the framework for its implementation, considering the specifics of your firm.

Define the aims you are trying to reach via the program and the success criteria. Choosing the correct metric to estimate and compare avails and spending is critical. All advantages and expenses must be converted to a common currency to ensure exact comparisons; users often prefer the dollar.

What is a Cost Benefit Analysis?

Define expenses and gains

When conducting a study, it is essential to voice a complete checklist of spending and the results of activities that the plan will create. The register of expenses most often includes:

  • Direct costs have immediately connected the manufacturing of goods or the provision of services.
  • Indirect costs: these are fixed spending that is not immediately connected with the manufacturing procedures but is necessary for the everyday running of the organization, e.g., rent, utilities, etc.
  • Intangible costs: these are charges that are complicated to quantify in dollars, e.g., the impact on improving the customer experience.
  • Potential risk spending: the money you will have to spend if some force majeure disrupts the plan’s progress.

Having dealt with the spending, you may proceed to learn of benefits; they are also divided into several categories:

  • Direct benefits – rise in income from trading an additional product.
  • Indirect gains – grow the interest of buyers in your enterprise.

Once you’ve calculated all the advantages and charges, think about the plan’s life span. Have you assessed the profits and spending that are not present initially but may arise in time?

Enter the dollar or other currency sum of all charges and advantages

After you have compiled a checklist of all capital outflows and inflows, you must select the corresponding currency by assigning a dollar worth to each element. It is simplest to deal with direct advantages and expenses. In contrast, indirect and intangible spendings are more complicated to assess, so we recommend using a unique platform or seeking professional consulting.

Calculate the entire profits and charges and match the worth

Once you understand each advantage and expense, you can compute the sum of each checklist and compare them using the NPV and BCR techniques. Besides a simple capital comparison, returning to the structure indicated in the first paragraph is vital. Does the analysis demonstrate that you have achieved the purposes you identified as successful?

If the charges are more than the gains, consider whether there are alternatives to your selected plan.

Formulate a checklist of recommendations and start implementation

The specialist who performs the CBA needs to summarize the consequences obtained before transferring them to the management. He should voice the overall expenses, gains, and how the planned indicators match the actual parameters.

The program’s advantages outweigh its charges if the research demonstrates positive results. The firm must be aware of limited resources, which may cause the need to define one idea from several prospective options.

Final words

A CBA assists you in utilizing insights to make the optimal decision. It means you no longer have to flip a coin because you can confidently choose.

Making cost-benefit research can be daunting, especially when interacting with multiple stakeholders. To clearly and precisely figure out all parameters, it is better to entrust the analysis to Bookstime specialists. Interaction with experts will give you a full picture of the company’s financial position. We also help you track trends in important business parameters, create a sound budget, and use cash flow forecasts for planning. With professional consulting, you can not worry about your firm’s future!

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Author: Charles Lutwidge

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