To be exact, cost benefit analysis is a financial technique which helps in taking business decisions. This technique is used to compare the expected costs of the project with its expected benefits using a common metric. Moreover, this technique can be used to assess and evaluate the overall impact of a project in monetary and quantifiable terms. The potential results in general will help business owners in determining whether or not the project is feasible. On seeing the results, the business manager can decide to either give a go-ahead to the team or stop them from initiating it.
Let’s break down the cost benefit analysis further and explore the key elements of this technique.
Key Elements of the Technique – Cost Benefit Analysis
Here are some key elements of cost benefit analysis that will give an in-depth understanding of the technique.
Weigh Future Values Today
The cost benefit analysis is one of the essential tools of financial management. It gives a clear idea about the future values. In order to weigh future benefits against future costs you need to focus on two important aspects: Firstly, you should look far into the future in order to identify the benefits; secondly look through your assumptions that are the basis of your analysis.
If you focus on these two, you will be able to forecast the future values in a reasonable manner with the help of the Net Present Value.
Dollar Value in a Cost Benefit Analysis
Not all projects a business takes up are financial. Sometimes the goal is to improve the morale of the existing employees. While you can easily attach a future monetary value to increase in revenue or reduction in costs, things like reduced employee turnover, less number of absences, or increased employee productivity are often difficult to value.
Since every element on the cost benefit analysis gets a monetary value, businesses often resort to yardstick measures calculated on standard assumptions. For example: A company with 100 employees records $1,000,000,000 worth of sales. If it were to calculate the benefit of reduced absences it needs to assign a monetary value to each absence. If one employee earns approximately $28,000 for the company every day [(1,000,000,000/100)/360] then an average reduction of 1 absence per employee can bring an increase of $2,800,000 (28,000×100) in the total revenue of the company.
What is the Purpose of the Cost Benefit Analysis?
Cost benefit analysis is a financial technique that is specifically designed to predict the future worth of projects. Portraying all the positives and negatives, the cost benefit analysis technique helps in determining the depth of the project. To break the purpose of the cost benefit analysis, here are the two main reasons and purposes of the cost benefit analysis.
- To help in comparing projects in terms of total expected cost and expected benefits of each option, determining if the benefits outweigh the costs or not.
- To understand if the investment is sound, feasible, and justified.
Provided these, the cost benefit analysis is used by governments, organizations, and most importantly business owners alike. The cost benefit analysis offers well educated estimates for the best alternatives.
Now that you know the importance of the cost benefit analysis, you may be wondering how to go about it. We have made it quite simple for you, all you need to do is follow the procedure listed below and use our cost benefit analysis template to get results.
How to Make Cost Benefit Analysis?
One may assume that conducting a cost benefit analysis may be very easy and simple, but to ensure that it is accurate and correct is actually difficult. That being said, here is the procedure to effectively conduct the cost benefit analysis.
Think Over the Costs and Benefits
The first and foremost thing in making the cost benefit analysis is to identify the drivers of costs and benefits. These are main items that will determine the results and add in the content of the cost benefit analysis template. Now the question arises, how to identify them?
Ways to Identify Costs
Here are the ways to identify all potential costs to add in the cost benefit analysis template.
- You can make the list of all the monetary costs that are going could be incurred on implementation. These costs may include:
- Start up fees
- Payroll expenses
- Production materials
- Travel expenses
- User acceptance processes and many others
- Secondly, you should make a list of all non-monetary costs that can be absorbed. Such types of costs include:
- Lost production on other tasks
- Potential risks
- Imperfect processes
- Market penetration or saturation uncertainties.
- After identifying the monetary and non-monetary costs, it is time to assign monetary values in steps. The monetary values are stated in present terms to ensure the equality across time.
- After compiling all three costs and values, you can add the anticipated costs together to get the value of total costs.
Ways to Identify Benefits
After identifying the costs, the next step is to quantify the benefits for the successful implementation. Therefore here are the some more ways to identify all potential benefits to put in the cost benefit analysis sample.
- You can make a list of all monetary benefits that you are going to experience on and after the implementation of your project.. These benefits include the income and saving that can be directly attributed to the project. They may include the following.
- Decreased production costs
- Increased contribution from investors
- Increased production capabilities
- The next step is to make a list of all the non monetary benefits that one can experience. The list of these benefits include:
- Greater customer base
- Increased durability
- Increased reliability
- Decreased production times
- Greater customer satisfaction
- Greater market saturation
- Improved project reputation
- Improved company and others
- After analyzing the monetary and non monetary benefits, you also need to assign monetary values to the identified benefits in both the steps. Also, you need to ensure that the monetary values should be stated in present value terms.
- In the end, you should add all the anticipated benefits to get a sum of the total benefits value.
Compare the Costs and Benefits
After identifying and brainstorming the costs and benefits, it’s time to compare the value of your costs with the value of your benefits. After the comparison you can use the analysis to decide the next course of action.
Evaluating the Cost Benefit Analysis
On calculating the benefits and costs, the two results and values that will come out will help you in determining whether or not the benefits outweigh your costs. This is stage where you can consider the payback time period, finding out how long it is going to take to reach the time when benefits will exactly be equal to the costs – the breakeven point.
Moreover, some experts believe that if the costs and benefits are roughly equal to each other, it is always better to re-evaluate the costs and benefits and revise the entire cost benefit analysis. They believe that there may be items missing or incorrectly quantified. On revising if you find that the benefits are greater than the costs, the action will be a worthwhile investment and should be looked upon as an opportunity.
What is the Cost Benefit Analysis Template?
The format and style of the cost benefit analysis is very simple. Since the beginning of this article, we’ve been discussing benefits and costs. Hence it is inarguable that they make the main headings of the cost benefit analysis template. Below them we list the particulars. Other elements of a cost benefit analysis entail:
The first and foremost step in preparing cost benefit analysis is the executive summary and description of the project. In this section, you just need to include a single paragraph highlighting the details of the project. You can take help from the proposal of the project to draft the executive summary.
Purpose of the Project’s Analysis
After writing the executive summary, the next section details the purpose of the analysis. Briefing about the project’s analysis, you are required to write the project’s name and reason for conducting the analysis. In general, all business owners do cost benefit analysis to determine the feasibility of the project, but by purpose we mean, you need to write how helpful this project can be for your business and to others. Also, you need to highlight the following key areas to determine the project’s purpose.
- Name of the organization
- Name of the project and decision question
- ID number of the project
- Project description
- Operational status of the project (if dealing with software)
Details or List of the Alternatives
In this third section, you are going to either list down or provide a description of the alternative approaches for the project. The description for the alternatives should brief about the current market, the services, and the products. Providing details of the current situation, the information can help others in understanding about the alternatives.
Now this is one of the most important sections, where you have to highlight all the monetary and non monetary costs, operating and developing alternatives described in the previous section. These costs may include the following and will help in determining the results.
- Operational costs
- Development costs
- Recurring costs (overhead, utilities, leases etc)
- Non-recurring costs for example capital investment costs
This section will highlight the expected monetary and non monetary benefits that can be achieved out of the potential business project. Here are the examples of benefits that you will need to include in this section.
- Recurring benefits for example lower overheads
- Labor cost reductions
- Cost reductions for example value enhancements
Evaluation and Comparative Cost Benefit Analysis Summary
This is the last and final section highlighting the summary and briefing the results. In this section, you have to present the elements and facts in a manner that they determine comparison. Unlike the benefits and costs section, this section should include the following details.
- Expected benefits for each alternative over the lifetime
- Expected costs over the estimated lifetime
- Comparison and evaluation of both of them
- Recommendations and suggestions for the comparison
- Supplementary reasons for the recommendations
When Should You Choose Cost Benefit Analysis?
Cost benefit analysis is generally undertaken for any kind of project involving capital expenditure, policy development, setting of standards, and use of assets. If the nature of the project is easy going the results will be quick, but if it is complex they may take time in evaluation. The analyses of the cost benefit analysis are really comprehensive, so all those looking for a boarder perspective and view for their costs and benefits should definitely consider using a cost benefit analysis.
Precisely, the cost benefit analysis is a relatively straightforward and simple financial technique deciding whether or not to pursue a project. You just need to see the costs and benefits associated with the project and then estimate if you are getting any real timely benefits or not. Also, with this technique, you can foresee how much time will be required to cover or repay the costs.
By performing the cost benefit analysis, you can valuably weigh the pros and cons of the action you take a plunge for. All the costs and benefits can be identified in the most accurate way for your projects and make you go for the opportunity if it is really worthwhile. If you are also looking forward to a new project but are unsure about the gains and losses, do not wait to download a cost benefit analysis template from here.
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