Purpose
When you and your organisation produce innovative ideas, you need to establish whether or not you should invest money and effort into developing them. The same applies to solutions that you believe are the answer to challenges and problems. You must ask if it is worthwhile to put your solutions into effect.
This is where Cost Benefit Analysis comes in. Cost Benefit Analysis is a popular tool for helping you decide whether to go ahead with a proposed course of action.
How To Use Cost/Benefit Analysis
The principle of using Cost Benefit Analysis is simple. You calculate in monetary terms the value of the benefits involved in taking a particular decision. From this figure, you subtract the costs.
The benefits may not be immediate. They often accrue over time. As part of the Cost Benefit Analysis, you therefore include a payback period.
The payback period is the same as the break-even point. You work out the time you have to wait before the value of the benefits repays all of the costs you incur.
Cost Benefit Analysis can become more complicated if you consider benefits and costs that don’t have an obvious financial value. For example, if you propose moving your office away from a centre of population, what is the “cost” of expecting your staff to commute for longer hours?
You therefore discuss such matters within your organisation. You establish the agreed value of moving an office away from a centre of population and the cost.
Limitations
When you conduct a Cost Benefit Analysis, you express the results in pounds. But because you have to estimate some benefits and costs, your figures may prove to be inaccurate. Future factors such as an unexpected high rate of inflation or fluctuations in currency exchange may lead to serious discrepancies when the actual cost of a project becomes clear.
Cost Benefit Analysis also fails to account for issues such as the social and environmental effects of an organisation’s decisions.
But you can overcome these problems. When you run a Cost Benefit Analysis, you must study the likelihood of future economic changes and build these into your model. And you can use techniques such as those given below to account for other issues.
Related Subjects
- Social Return on Investment. This is an extension of Cost Benefit Analysis. Social Return on Investment examines social and environmental impacts of management decisions.
- Economic Impact Analysis. An organisation’s decisions and projects may affect an area’s economy. This area may be anything from a small rural community to the world. Economic Impact Analysis looks at changes in an area’s income, employment and growth that may follow on the heels of an organisation’s activities.
- Cost Effectiveness Analysis. This type of analysis compares the results and costs of two or more similar projects proposed by an organisation. Cost-Effectiveness Analysis does not draw monetary conclusions. Instead, it looks at other forms of measurement such as an improvement in life expectancy.
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