Imagine that you’ve recently taken on a new project, and your people are struggling to keep up with the increased workload.<\/p>
You are therefore considering whether to hire a new team member. Clearly, the benefits of hiring a new person need to significantly outweigh the associated costs.<\/p>
This is where Cost-Benefit Analysis is useful.<\/p>
CBA is a quick and simple technique that you can use for non-critical financial decisions. Where decisions are mission-critical, or large sums of money are involved, other approaches \u2013 such as use of Net Present Values<\/a> and Internal Rates of Return<\/a> \u2013 are often more appropriate.<\/p><\/div><\/div>\n\n Jules Dupuit, a French engineer and economist, introduced the concepts behind CBA in the 1840s. It became popular in the 1950s as a simple way of weighing up project costs and benefits, to determine whether to go ahead with a project.<\/p> As its name suggests, Cost-Benefit Analysis involves adding up the benefits of a course of action, and then comparing these with the costs associated with it.<\/p> The results of the analysis are often expressed as a payback period \u2013 this is the time it takes for benefits to repay costs. Many people who use it look for payback in less than a specific period \u2013 for example, three years.<\/p> You can use the technique in a wide variety of situations. For example, when you are:<\/p> However, bear in mind that it is best for making quick and simple financial decisions. More robust approaches are commonly used for more complex, business-critical or high cost decisions.<\/p>\n\n Follow these steps to do a Cost-Benefit Analysis.<\/p>\n\n First, take time to brainstorm<\/a> all of the costs associated with the project, and make a list of these. Then, do the same for all of the benefits of the project. Can you think of any unexpected costs? And are there benefits that you may not initially have anticipated?<\/p> When you come up with the costs and benefits, think about the lifetime of the project. What are the costs and benefits likely to be over time?<\/p>\n\n Costs include the costs of physical resources needed, as well as the cost of the human effort involved in all phases of a project. Costs are often relatively easy to estimate (compared with revenues).<\/p> It’s important that you think about as many related costs as you can. For example, what will any training cost? Will there be a decrease in productivity while people are learning a new system or technology, and how much will this cost?<\/p> Remember to think about costs that will continue to be incurred once the project is finished. For example, consider whether you will need additional staff, if your team will need ongoing training, or if you’ll have increased overheads.<\/p>\n\n This step is less straightforward than step two! Firstly, it’s often very difficult to predict revenues accurately, especially for new products. Secondly, along with the financial benefits that you anticipate, there are often intangible, or soft, benefits that are important outcomes of the project.<\/p> For instance, what is the impact on the environment, employee satisfaction, or health and safety? What is the monetary value of that impact?<\/p> As an example, is preserving an ancient monument worth $500,000, or is it worth $5,000,000 because of its historical importance? Or, what is the value of stress-free travel to work in the morning? Here, it’s important to consult with other stakeholders and decide how you’ll value these intangible items.<\/p>\n\n Finally, compare the value of your costs to the value of your benefits, and use this analysis to decide your course of action.<\/p> To do this, calculate your total costs and your total benefits, and compare the two values to determine whether your benefits outweigh your costs. At this stage it’s important to consider the payback time, to find out how long it will take for you to reach the break even point \u2013 the point in time at which the benefits have just repaid the costs.<\/p> For simple examples, where the same benefits are received each period, you can calculate the payback period by dividing the projected total cost of the project by the projected total revenues:<\/p> Total cost \/ total revenue (or benefits) = length of time (payback period).<\/p>\n\n Custom Graphic Works has been operating for just over a year, and sales are exceeding targets. Currently, two designers are working full-time, and the owner is considering increasing capacity to meet demand. (This would involve leasing more space and hiring two new designers.)<\/p> He decides to complete a Cost-Benefit Analysis to explore his choices.<\/p>\n\n <\/p><\/div><\/div> Category<\/p><\/th> Details<\/p><\/th> Cost in First Year<\/p><\/th><\/tr><\/thead> Lease.<\/p><\/td> 750 square feet available next door at $18 per square foot<\/p><\/td> $13,500<\/p><\/td><\/tr> Leasehold improvements.<\/p><\/td> Knock out walls and reconfigure office space<\/p><\/td> $15,000<\/p><\/td><\/tr> Hire two more designers.<\/p><\/td> Salary, including benefits<\/p> Recruitment costs<\/p> Orientation and training<\/p><\/td> $75,000<\/p> $11,250<\/p> $3,000<\/p><\/td><\/tr> Two additional workstations.<\/p><\/td> Furniture and hardware<\/p> Software licenses<\/p><\/td> $6,000<\/p> $1,000<\/p><\/td><\/tr> Construction downtime.<\/p><\/td> Two weeks at approximately $7,500 revenue per week<\/p><\/td> $15,000<\/p><\/td><\/tr> Total<\/strong><\/p><\/td> $139,750<\/strong><\/p><\/td><\/tr><\/tbody><\/table><\/div><\/div>\n\n <\/p><\/div><\/div>About the Tool<\/h2>\n\n
How to Use the Tool<\/h2>\n\n
Step One: Brainstorm Costs and Benefits<\/h3>\n\n
Step Two: Assign a Monetary Value to the Costs<\/h3>\n\n
Step Three: Assign a Monetary Value to the Benefits<\/h3>\n\n
Step Four: Compare Costs and Benefits<\/h3>\n\n
Example<\/h2>\n\n
Assumptions<\/h3>\n\n
Costs<\/h3>\n\n
Benefits<\/h3>\n\n