Cost Benefit Analysis
What is cost benefit analysis?
A cost benefit analysis is a process that businesses use to help in their decision-making before implementing a new strategy or undertaking a different course of action. It can also be used prior to starting a business as you set up your bookkeeping plans. They use this process to analyze decisions, actions or situations to determine whether carrying them out will be feasible and/or beneficial. Performing a cost benefit analysis involves identifying the benefits of a particular decision, action or situation as well as the costs associated with it, and then, after assigning monetary values to each of them, subtracting those costs from the benefits. The answer can help determine whether the benefits outweigh the costs, or vice versa, which will show whether it’s beneficial to implement a new strategy or course of action.
Who uses cost benefit analysis and why?
Businesses rely on cost benefit analysis to support decisions about a new strategy or course of action because it provides an objective view of the issue being evaluated based on evidence rather than on opinion, subjective bias or company politics. As it provides an unbiased assessment of the results of a decision, cost benefit analysis is frequently used when developing business strategies, evaluating new potential employees, creating a new business website or when making purchase decisions or budget allocations.
Besides business, cost benefit analysis is an important part of the decision-making processes across many sectors including government, non-profit, and finance.
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How to perform a cost benefit analysis?
Typically, running a cost benefit analysis can be divided into 3 accounting steps. These can include the following:
01: Making lists
To start performing a cost benefit analysis, the first thing to do is to create two separate lists that include all the costs and all the benefits involved with the potential decision or action.
Regarding the costs, consider more than just the obvious ones (like the cost of new equipment as well as the installation costs). This includes any potential intangible costs, like the opportunity cost of choosing certain pieces of equipment instead of others, or prioritizing the purchase of equipment over spending money on something else, such as an advertising campaign or hiring a new employee.
Regarding the benefits, consider how much this decision or course of action might boost your revenue, and what other benefits could be involved that might outweigh the costs. For instance, would new equipment enhance your company’s capabilities and make current operations run more efficiently? It’s important to also list any intangible benefits, like enhanced employee morale as well as obvious, monetary ones.
02: Assigning monetary values to each cost and benefit
With two separate lists of respective costs and benefits associated with the decision or course of action, you can now put monetary values next to each cost and benefit.
Some of the monetary values will be straightforward, like the purchase cost of the equipment and the installation cost. However, it helps to assign monetary values to tangible and intangible as well as direct or indirect costs or benefits. For example, installing new equipment in a bakery might mean the kitchen may be unusable for a few hours, costing the bakers hours and a decrease in product and therefore revenue generated.
Once monetary values for each cost and benefit have been assigned, it’s time to add together all the costs, and then do the same for all the benefits.
03: Plugging the numbers into the equation
Now it’s time to plug the numbers into the equation. This means deducting the overall sum of the costs from the overall sum of all the benefits.
If the end sum of the benefits outweigh the costs, it is recommended to move forward with the decision. If not, the company or team should reconsider the potential decision or course of action and make the relevant adjustments.