A cost-benefit analysis helps you compare potential projects to see which would be the most beneficial to your business. We break down some of the jargon to help you understand the process and set up your business for success.
Assigning dollar value
A cost-benefit analysis (CBA) subtracts the expected negative results of a project from the positives to help you decide whether it’s worth pursuing. The net result of a CBA is usually a dollar figure, so you must be able to assign a monetary value to every anticipated benefit and cost included in the analysis. Your financial controller or a trusted accountant can help work out the finer details.
This is easier when dealing with financial quantities, such as higher revenue and lower manufacturing cost. However, you may also need to include intangible factors. For example, increasing employee bonuses is a financial cost, but the intangible benefit (higher morale ) could result in financial gains, such as higher productivity, fewer absences and lower turnover.
Other factors you may need to consider include:
Accounting for time
Most benefits, along with future and ongoing costs, occur over time rather than right away, so will need to be converted to their net present value (NPV). This takes into account:
- The discount rate, which is used to calculate value in today’s dollars based on the expected rate of inflation. A positive rate
of inflation applied to a benefit will reduce its NPV.
- The payback period, i.e. the time frame over which the expected benefits or estimated costs are expected to occur.
Cost-benefit analysis example
The following is an example of the cost benefit of installing a new cloud-based customer service system. All figures are monthly and NPV adjusted.
Subscription cost = $1000
Staff training = $800
Other (e.g. sales lost during downtime) = $500
TOTAL = $2300
Equipment savings (servers, cables, software licences, maintenance, etc.) = $2000
New lead conversion = $300
Improved customer retention = $200
Efficiency improvements = $100
TOTAL = $2600
Net benefit = $300/month
Limitations of a cost-benefit analysis
A CBA always requires guesswork based on the best past and present data available. The further into the future you look, the more error prone the estimation will be. Converting intangible benefits (and costs) into money values can also be a challenge.
A cost-benefit analysis can still, however, serve as a valuable decision tool, as well as a good way to clearly define project objectives and measure project success.
Implementing a cost-benefit analysis on a future project could help you forecast your cash flow, and vice versa. Learn how to take clues from the past to look to the future of your business.