A cost-benefit analysis is a vital part of starting and running any project.
In this article, we talk about how they work and what you need to do to perform one.
Here’s what we cover:
- What is a cost-benefit analysis?
- Start by attaching values to your project
- Consider potential costs
- Do a comparison to see if benefits outweigh costs
- Final thoughts
What is a cost-benefit analysis?
In practice, a cost-benefit analysis is the comparative assessment of benefits along with its associated costs.
It gives you the information you need to frame objectives, calculate estimates of needed resources, and define objectives.
Performing one isn’t difficult, but it is often overlooked.
Let’s look at how one works.
Start by attaching values to your project
The first step of your analysis is to attach a value to every aspect of your project or business.
For some things, this is easy – physical assets have a monetary value, for instance.
More difficult is calculating values for things such as labour. These values may have to be estimated.
Wherever possible, you should express these values in monetary terms.
You should also take note of what costs are recurring and what aren’t.
Additionally, you’ll want to consider some potential values:
- The cost of not doing a project
- The cost of your project or business failing
- The opportunity costs, or the potential benefits you may have accrued had you invested your time elsewhere.
Consider potential costs
No project happens in one moment, so it’s important to consider the potential costs of your project over time – obviously, noting your recurring costs above facilitates this.
Alongside this, you need to work out how far into the future you expect to accrue benefit from your project, as well as certain assumptions:
- Inflation needs to be considered in your analysis, although you’ll want to convert all values into current monetary values (real cost).
- Lost return on your investment is the amount you would have made by investing the money you spent on the project.
These two figures give you the net present value of your project.
It’s also worth keeping in mind that the further into the future your estimates go, the less reliable they are, as a changing environment can make them redundant.
Do a comparison to see if benefits outweigh costs
Once you have calculated your costs and benefits, you’ll need to compare them quantitatively to determine if the benefits outweigh the costs.
If they do, then you have the rationale needed to go forward with the project, based on your objectives and goals.
If they don’t, you’ll need to go back to the drawing board – review your proposed project to see if adjustments are possible that will allow you to take it forward.
If this isn’t possible, you may have to abandon your project. But on the bright side, at least you’ll have saved time and money by not pursuing something that wouldn’t provide the desired result.
Taking the time to perform a cost-benefit analysis is worth your while for any projects or business ideas that you’d like to pursue.
It’s good to carry them out before you get too attached to an idea.
And as covered above, they can help you save time and money if your project isn’t deemed to be something that will help you reach your goals.
On the flip side, performing the analysis can show you that actually, you’re on the right path with your project.
If that’s the case, now it’s time to put it into action.
Recommended Next Read
Write a small business plan that works
Never miss an episode
Subscribe by email and get Sound Advice delivered to your inbox every month with the Sage Advice newsletter with a ton of related articles, templates and problem-solving guides for small businesses so you can put our sound advice into practice.