cost-benefit-analysis

Cost-Benefit Analysis In A Nutshell

A cost-benefit analysis is a process a business can use to analyze decisions according to the costs associated with making that decision. For a cost analysis to be effective it’s important to articulate the project in the simplest terms possible, identify the costs, determine the benefits of project implementation, assess the alternatives.

Understanding a cost-benefit analysis

Before undertaking any new project, a business must conduct a cost-benefit analysis (CBA) to determine whether the project is financially viable. In other words, does the forecast revenue exceed the forecast costs?

A cost-benefit analysis is also important in guiding the decisions that are made within a project. This gives project managers a systematic approach to determining the worthiness of various transactions, tasks, investments, and other business requirements.

Ultimately, the cost-benefit analysis gives project managers objective guidance on the approach that will best minimize costs. It also prevents businesses from falling in love with ideas that sound good on paper but which do not generate any return on investment.

Performing a cost-benefit analysis

There is no universal approach to performing a cost-benefit analysis, but certain steps will apply to most businesses and industries:

1 – Articulate the project in the simplest terms possible

First, the project must be clearly articulated and defined in simple terms. This step is important because clarity in defining the problem leads to less clarification work later on.

For example, a farm machinery company looking to add new models to its fleet should assess each model based on whether or not consumers would buy it. It should not, on the other hand, look to increase its fleet based on unpredictable future climate cycles or commodity prices.

2 – Identify the costs

When identifying the costs, it’s crucial that businesses think laterally and include:

  • Direct costs – manufacturing, inventory, and raw materials.
  • Indirect costs – rent, electricity, and other utilities.
  • Intangible costs – or impacts a decision will have on relevant stakeholders.
  • Opportunity costs – for example, the costs associated with hiring new staff members versus outsourcing the work temporarily.
  • Risk costs – or the costs associated with risks related to environment, compliance, or competition.

3 – Determine the benefits of project implementation 

Are real or perceived benefits worthy of investment? That is, do the benefits align with broader company goals or objectives?

Benefits might encompass:

  • Revenue and sales.
  • Enhanced employee safety or morale.
  • Customer satisfaction through faster delivery or valuable product offerings.
  • Competitive advantage and attainment of market share.

4 – Assess the alternatives

Does there exist a more economical way of achieving the aforementioned benefits? This process is called the opportunity cost, defined as the benefits that are realized when choosing one alternative over another.

Regardless of whether an alternative course of action exists, compare the total costs against the total benefits to make the most informed decision. Businesses can do this by considering the payback period, or the period required for the business to recoup costs and break even.

Cost-benefit analysis best practices

  • The CBA is best suited to projects involving policy development, capital expenditure, asset usage, and protocol establishment. Each will require a robust economic analysis that may require the external consultation of an experienced evaluator.
  • The most effective cost-benefit analyses consider a broad and holistic view of costs and benefits over the short and long term. By ensuring that the analysis is comprehensive, there is more chance that every affected stakeholder will be included.
  • Much of the risk involved with this analysis lies in subjectivity. Stakeholders or other interested parties can sometimes exaggerate benefits while understating costs. There can also be a reliance on historical data to predict future trends. In this situation, businesses must perform a rigorous initial analysis to counteract any pre-existing biases 

Key takeaways

  • A cost-benefit analysis provides an objective assessment of the costs and benefits of taking a particular action.
  • A cost-benefit analysis begins with clearly defining a simple problem and identifying the costs and benefits in the context of company objectives. Then, alternatives are assessed according to the time required to realize profitability.
  • A cost-benefit analysis is a broad and holistic analysis that should include all relevant stakeholders. But it does require that businesses maintain objectiveness without reliance on historical data or pre-existing biases.

Connected Analysis Frameworks

Cynefin Framework

cynefin-framework
The Cynefin Framework gives context to decision making and problem-solving by providing context and guiding an appropriate response. The five domains of the Cynefin Framework comprise obvious, complicated, complex, chaotic domains and disorder if a domain has not been determined at all.

SWOT Analysis

swot-analysis
A SWOT Analysis is a framework used for evaluating the business’s Strengths, Weaknesses, Opportunities, and Threats. It can aid in identifying the problematic areas of your business so that you can maximize your opportunities. It will also alert you to the challenges your organization might face in the future.

Personal SWOT Analysis

personal-swot-analysis
The SWOT analysis is commonly used as a strategic planning tool in business. However, it is also well suited for personal use in addressing a specific goal or problem. A personal SWOT analysis helps individuals identify their strengths, weaknesses, opportunities, and threats.

Pareto Analysis

pareto-principle-pareto-analysis
The Pareto Analysis is a statistical analysis used in business decision making that identifies a certain number of input factors that have the greatest impact on income. It is based on the similarly named Pareto Principle, which states that 80% of the effect of something can be attributed to just 20% of the drivers.

Failure Mode And Effects Analysis

failure-mode-and-effects-analysis
A failure mode and effects analysis (FMEA) is a structured approach to identifying design failures in a product or process. Developed in the 1950s, the failure mode and effects analysis is one the earliest methodologies of its kind. It enables organizations to anticipate a range of potential failures during the design stage.

Blindspot Analysis

blindspot-analysis
A Blindspot Analysis is a means of unearthing incorrect or outdated assumptions that can harm decision making in an organization. The term “blindspot analysis” was first coined by American economist Michael Porter. Porter argued that in business, outdated ideas or strategies had the potential to stifle modern ideas and prevent them from succeeding. Furthermore, decisions a business thought were made with care caused projects to fail because major factors had not been duly considered.

Comparable Company Analysis

comparable-company-analysis
A comparable company analysis is a process that enables the identification of similar organizations to be used as a comparison to understand the business and financial performance of the target company. To find comparables you can look at two key profiles: the business and financial profile. From the comparable company analysis it is possible to understand the competitive landscape of the target organization.

Cost-Benefit Analysis

cost-benefit-analysis
A cost-benefit analysis is a process a business can use to analyze decisions according to the costs associated with making that decision. For a cost analysis to be effective it’s important to articulate the project in the simplest terms possible, identify the costs, determine the benefits of project implementation, assess the alternatives.

Agile Business Analysis

agile-business-analysis
Agile Business Analysis (AgileBA) is certification in the form of guidance and training for business analysts seeking to work in agile environments. To support this shift, AgileBA also helps the business analyst relate Agile projects to a wider organizational mission or strategy. To ensure that analysts have the necessary skills and expertise, AgileBA certification was developed.

SOAR Analysis

soar-analysis
A SOAR analysis is a technique that helps businesses at a strategic planning level to: Focus on what they are doing right. Determine which skills could be enhanced. Understand the desires and motivations of their stakeholders.

STEEPLE Analysis

steeple-analysis
The STEEPLE analysis is a variation of the STEEP analysis. Where the step analysis comprises socio-cultural, technological, economic, environmental/ecological, and political factors as the base of the analysis. The STEEPLE analysis adds other two factors such as Legal and Ethical.

Pestel Analysis

pestel-analysis
The PESTEL analysis is a framework that can help marketers assess whether macro-economic factors are affecting an organization. This is a critical step that helps organizations identify potential threats and weaknesses that can be used in other frameworks such as SWOT or to gain a broader and better understanding of the overall marketing environment.

DESTEP Analysis

destep-analysis
A DESTEP analysis is a framework used by businesses to understand their external environment and the issues which may impact them. The DESTEP analysis is an extension of the popular PEST analysis created by Harvard Business School professor Francis J. Aguilar. The DESTEP analysis groups external factors into six categories: demographic, economic, socio-cultural, technological, ecological, and political.

Paired Comparison Analysis

paired-comparison-analysis
A paired comparison analysis is used to rate or rank options where evaluation criteria are subjective by nature. The analysis is particularly useful when there is a lack of clear priorities or objective data to base decisions on. A paired comparison analysis evaluates a range of options by comparing them against each other.

Related Strategy Concepts: Go-To-Market StrategyMarketing StrategyBusiness ModelsTech Business ModelsJobs-To-Be DoneDesign ThinkingLean Startup CanvasValue ChainValue Proposition CanvasBalanced ScorecardBusiness Model CanvasSWOT AnalysisGrowth HackingBundlingUnbundlingBootstrappingVenture CapitalPorter’s Five ForcesPorter’s Generic StrategiesPorter’s Five ForcesPESTEL AnalysisSWOTPorter’s Diamond ModelAnsoffTechnology Adoption CurveTOWSSOARBalanced ScorecardOKRAgile MethodologyValue PropositionVTDF FrameworkBCG MatrixGE McKinsey MatrixKotter’s 8-Step Change Model.

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