What is a cost benefit analysis?
Cost benefit analysis, CBA, benefit cost analysis, or if one loves hyphens (or incorrect depending on your perspective) cost-benefit analysis / benefit-cost analysis. All effectively mean the same thing - how much the benefits of a project investment outweigh the costs.
CBA was originally pioneered by Jules Dupuit in 1848 which (according to Wikipedia) focused on the “the social profitability of a project like the construction of a road or bridge”. What was revolutionary about the early idea (and the reason why it persists today almost 200 years later) was to make something that was difficult to measure (social profitability or the benefit to a society in the initial case) quantifiable. Ongoing use by governments has continually enforced CBA as an optimal way to evaluate whether a project is worth doing or an investment is worth making.
In project management, benefits can come in many forms. The formula for cost benefit analysis will only work effectively if the units for benefits are the same as cost i.e. in monetary terms.
With certain projects this might prove tricky such as regulatory or compliance projects however one way to potentially address this is to look at compliance costs as a negative benefit which is “ the undesirable effect of a decision or action (or the failure to decide or act on it” such as the effect of failing to be compliant will equal $X fines.
What is the formula for CBA?
The output of cost benefit analysis will show the net benefit (benefits minus cost) of a project decision. For example:
Project A: Build a new product will cost 100,000 with expected sales of 100,000 per unit (unit price = 2). The sales of benefits therefore are 200,000. The simple calculation for CBA for this project is 200,000 monetary benefit minus 100,000 cost equals a net benefit of 100,000.
Project B: Enhance the sales portal to position products in a simplified way, add a shopping basket and add a ‘keep shopping feature’ when checking out to allow multiple products in one purchase. The cost is 20,000 with expected increases of sales equal to 200,000 of revenue. The simple calculation for CBA for this project is 200,000 monetary benefit minus 20,000 cost equals a net benefit of 180,000.
Based on comparison of these two metrics, a project investment board or stakeholder can easily quantify the best use of investment dollars for the greatest return.
One key issue with the simple calculation though is the concept of time and the impact it can have on value. This is the concept that money you have now is worth more than the identical sum in the future due to its potential earning capacity. In other words, the sooner you put a dollar in the bank, the sooner it starts earning interest. So when comparing a cost (today’s value) with a benefit (some time in the future’s value) you run the risk that your outputs could be incorrect and therefore misinform decisions. This is where Net Present Value comes in where you convert all values in the calculation to today’s (present) value.
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What is the process for CBA?
Like any project process, there are multiple versions out there on what the steps are and it is always best to find what works best for you. Here are some suggested steps to follow to ensure you can get the most out of CBA in your project decision making.
- Define the project (options considered, goals, objectives and other information)
- Quantify costs and benefits and confirm which ones are applicable in a CBA calculator (not all benefits can be and some costs may not be considered investment funds)
- Standardise the metrics in the calculations (define currency, units of value, NPV etc. as required)
- Complete relevant calculations (simple CBA or more advanced NPV depending on how accurate you need to be)
- Perform sensitivity analysis which accounts for uncertainty and shows how changes in different variables could affect the overall costs and benefits. It will be a way to give visibility to stakeholders on the assumptions and variables within the calculation which may be subject to change. A simple way to present this information might be in a best case / worst case analysis which provides the range of outcomes should assumptions change over time
- Complete the business case inclusive of CBA outputs and engage stakeholders
CBA in whatever form is a necessary process all organisations should consider in order to assist decision making and ensure investment funds are spent on projects which promise the greatest return. It will also assist with better ownership and governance over benefits realisation once the project starts which is critical.
Cost benefit analysis FAQs
What is cost benefit analysis?
Cost-benefit analysis (CBA) is a process or tool to support decision making in projects.
CBA evaluates the cost versus the benefit of a project to determine project feasibility as well as provide a decision making metric when weighing up multiple options.
What are cost benefit analysis examples?
The output of cost benefit analysis will show the net benefit (benefits minus cost) of a project decision. For example:
Build a new product will cost 100,000 with expected sales of 100,000 per unit (unit price = 2). The sales of benefits therefore are 200,000. The simple calculation for CBA for this project is 200,000 monetary benefit minus 100,000 cost equals a net benefit of 100,000.
What is the process for cost benefit analysis?
Here are some suggested steps to follow to ensure you can get the most out of CBA in your project decision making:
- Define the project
- Quantify costs and benefits
- Standardise the metrics in the calculations
- Complete relevant calculations
- Perform sensitivity analysis
- Complete the business case inclusive of CBA outputs and engage stakeholders