If you've struggled to do what's best for the business in the past, then cost-benefit analysis is an excellent means of getting the most from every idea, option and investment you and your company are involved in.
Whether you'd like to improve your decision-making, you're looking to weigh up the pros and cons of a proposed project, or the company needs to navigate the repercussions of upcoming change; cost-benefit analysis can equip you with the skills to deal with a variety of business challenges.
Here, we'll delve deeper into cost-benefit analysis, including its benefits, how to properly perform the process, and provide you with an example template to help you calculate your future analyses.
What is a cost-benefit analysis?
A cost-benefit analysis is the process of comparing the projected or estimated costs and benefits (or opportunities) associated with a project to determine whether it makes sense from a business perspective.
Broadly, cost-benefit analysis involves tallying up all the costs of a project or decision and subtracting that amount from the total projected benefits of the project or decisions. This value is sometimes represented as a ratio.
Upon completion, a cost-benefit analysis will yield concrete, actionable results that can be used to come to reasonable conclusions around the feasibility or advisability of a particular decision or situation. If the projected benefits outweigh the costs after calculation, the decision is a sound one to make.
If, however, the costs outweigh the benefits, then your business may want to reconsider before making the decision.
Keep in mind that a cost-benefit analysis' data-driven approach is used by both larger, more established companies and newer startups. The basic principles and framework can be applied to virtually any decision-making process – whether it's business-related or not.
How to perform a cost-benefit analysis: A step-by-step guide
For your analysis to be as accurate as possible, the framework in which you're conducting it needs to be established. What your framework looks like is dependent on the specifics of your organisation.Identify the goals and objectives that you're trying to address with the proposal. What needs to be done in order for things to be a success? Doing so helps you to identify and then understand your costs and benefits, both of which are critical when it comes to interpreting the results of your analysis.
You should also decide what metric you'll be using to measure and compare the benefits and costs. To accurately compare the two, both cost and benefit should be measured in the same "common currency". By this, we don't mean an actual currency, but it does frequently involve giving a monetary amount to each potential cost and benefit.
Next, you should compile two separate lists: one for all projected costs, and the other list for the expected benefits of the proposed project or action.
When tallying costs, begin with direct costs, i.e. expenses directly related to the production or development of a product or service (or the implementation of a project or business decision). Labour costs, manufacturing costs, materials costs and inventory costs all fall under direct costs.However, you should also be mindful of other costs to account for, including:
Benefits to keep in mind can include:
After compiling these lists, assign a value to each one; this will make accurately comparing them a lot easier.
Direct costs and benefits tend to be easiest to assign value to, whereas indirect and intangible costs and benefits can be tougher to quantify. Thankfully, there are software options and methodologies out there which can assign values to these metrics.
Once every cost and benefit has a value next to it, you can tally up each list and compare the two and use this decide whether there’s a business case for you to act on.
Return to the framework from step one, too. Does the analysis show you reaching the goals you've identified as markers for success or are you falling short? If costs outweigh benefits, are there alternatives to the proposal that haven't been considered? Additionally, you may be able to identify things like cost reductions, so you can more affordably reach your goals.
Simplified business decisions
Different business projects might entail vastly different types of expenses and details at a low level, but a cost-benefit analysis views every project in the same simple terms: total benefits minus total costs equals net benefit. This simplicity allows businesses to compare projects of all types, despite how dissimilar they may seem.
Allows projects to be viewed objectively
Even if better options are available, small business owners and team leaders may become attached to certain projects if they've invested time in them. By comparing projects based on the actual financial costs and benefits, it eliminates this more emotional element, helping decision makers overcome their personal inclinations towards certain projects for the good of the business.
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Allows for clearer goal setting
The estimation of costs and benefits as a result of cost-benefit analysis can give a business an idea of the lowest amount of revenue a new project requires to break even, helping to set revenue goals to make future projects more profitable.
Here, we’ve provided you with a handy template to help get you started with your own cost-benefit analysis.
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