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Understanding Cost Benefit Analysis

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Last editedJul 20212 min read

Decision-making within business can be a complicated process. Ultimately, as an SME owner, your actions can result in the success or failure of the organization. Are you unsure whether or not to take the plunge with that new project or idea? Is it the right time to make those changes to your marketing strategy? What long-term value will you get from expanding the workforce? These kinds of questions can be answered by conducting a cost benefit analysis.

What is cost benefit analysis?

The cost benefit analysis definition is relatively straightforward. It can be explained as a systematic process that businesses use to determine whether or not a decision they are contemplating making is worthwhile. In other words, it’s a form of comparison, which involves tallying up the estimated expenses and rewards associated with a future business proposal. Cost benefit analysis is utilized by both start-ups and established companies, and can be applied to virtually any situation that includes data-driven decision-making.

How to do a cost benefit analysis

1. Establish a framework

The first step involved in carrying out a cost benefit analysis is to form a framework that’s right for your business. This will ensure your analysis is as accurate as possible. You will need to start by identifying your goals and objectives, and choosing the metric, or common currency, you will be using to compare the costs and benefits of your proposed project or action. Many businesspeople create their own from scratch, but you may prefer to use, or take inspiration from, a cost benefit analysis template.

2. Identify your costs and expected benefits

Next, compile two separate lists - one of the projected costs and one of the expected benefits of your proposed project or action. Principally, look at direct costs, including labor, manufacturing, materials and inventory expenses, but also take indirect costs, intangible costs and opportunity costs into consideration. When determining the benefits, explore direct benefits, such as increased revenue from a product, as well as indirect benefits, which could include things like increased customer loyalty and interest in your brand.

3. Assign monetary value to the costs and benefits

Once you have identified your costs and benefits, you then need to assign monetary value to each one. This will allow you to compare them accurately. It will be easy to do this with direct costs and benefits, but indirect and intangible costs or benefits may be more problematic to assess. It’s still important to try to calculate indirect and intangible costs or benefits. If you’re struggling, there are various types of software and methodologies to explore, which can prove helpful.

4. Find the total and compare the costs and benefits

The final step is to tally up the costs list and the benefits list, and then compare the two. If the total benefits outnumber the total costs, it indicates that the decision is a good one and you may wish to proceed with the proposal. However, if the total costs outweigh the total benefits, then you may want to reconsider the proposal or make some adjustments. Ask yourself this - does the analysis show you reaching your goals and objectives, or does it disappoint? At the end of the day, you don’t want to throw money away - there needs to be profit in the long run.

Cost benefit analysis example

Are you still unsure about how to do a cost benefit analysis? Are you wondering how it will apply to your business? Here’s a cost benefit analysis example.

A magazine publisher has been operating for just over a year, and sales are exceeding targets. The owner of the business is now considering increasing capacity to meet demand, which would involve leasing more office space and hiring new staff, including one new designer and three new sales members. A cost benefit analysis is carried out to explore her choices.

As you can see from the cost benefit analysis, the total benefits exceed the total costs, making the publisher’s expansion plans seem, overall, a good, profitable business decision.

There are various cost benefit analysis templates to explore online, which can help make the process that little bit quicker and easier.

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