What is Cost-Benefit Analysis?
A Cost-Benefit analysis is a systematic method used to estimate an organisation’s strengths and weaknesses against available options, in order to make decisions that provide maximum benefits at minimal costs. A CBA estimates the rewards or positive outcomes of a particular strategy or tactic, and then detracts the total costs associated with it in order to identify the net returns.
A Cost-Benefit analysis can be run on multiple scenarios or one scenario while changing a variable in order to determine which will provide an optimal outcome. This process is most commonly used before undertaking large projects, strategic decisions or policy changes.
What are the applications of a Cost-Benefit Analysis?
A Cost-Benefit Analysis can be used for;
- Investment planning: Is the investment sound, how much would be gained, what can be lost, is it worth pursuing, how much can be safely invested, where should it be invested.
- Strategic planning: what is the cost of each tactical plan to execute a strategy, what is the net outcome for each plan, what happens if one element is changed, compare different plans and select the most viable to implement the strategy.
- Policy planning: If x action is taken what is the impact on the current situation, what is the impact on the future, what is the current cost required, what savings will this action enact in the future, how long will it take for the savings to outweigh the costs, is it feasible.
Steps in a general Cost-Benefit Analysis
- Define the objective
- List all actions required to achieve the objective
- List all stakeholders involved to achieve the objective
- List all essential resources required to achieve the objective
- List potential risks and threats that may occur to achieve the objective
- Determine measures of evaluation and costs for each step
- List all costs associated with plans, steps, stakeholders and items needed to achieve the objective
- List estimated benefits of the objective over specified time periods
- Converts all costs and benefits to a single currency
- Detract costs from benefits to get net outcome
Apply scenario analysis and repeat steps. For example:
- What is the cost-benefit analysis of continuing in the present circumstance, policy or strategy?
- What is the cost-benefit analysis if you change key variables: eg location, software, hardware etc.
Once the CBA has been applied to all scenarios, select the plan that provides the optimal desired outcome.
A cost-benefit analysis can be useful not just in business, finance or organisations but also with regards to personal financial matters. This process can be used when making any major decisions that has a long-term impact on an individual’s finances, lifestyle or circumstances, in order to make the right choice.