No matter how large an organization is, funds are seldom endless. As a result, it only makes sense to conduct a cost-benefit analysis of projects or initiatives before diving in and spending money that may not help your company in the long run.
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What is a cost-benefit analysis?
The cost-benefit analysis process helps companies to analyze and evaluate the cost of a project and the benefits gained from proceeding with that project. A cost-benefit analysis should consider both quantitative and qualitative factors to make a base case for the investment. It should also compare similar projects to determine the potential, benefits, risks, and likelihood of success.
When should you conduct a cost-benefit analysis?
A cost-benefit analysis should be conducted before allocating funds to a project. A thorough analysis of a project should identify all potential benefits and the probability of achieving goals, compared with the all-in associated costs. The outcome of the analysis will help decision makers determine if the project is feasible and if it should proceed, or if the funds are better spent elsewhere. If a project is to go ahead, the benefits should outweigh the costs and meet the intended goals.
A thorough cost-benefit analysis should identify the purpose and goals behind the project, gather business and project requirements, identify all of the resources to be used, determine the metrics to measure success, and consider other potential options.
How do you do a cost-benefit analysis?
When conducting a cost-benefit analysis, make sure to factor in these three important things.
1. Analyze all cost types
- Direct costs: Direct costs can be easily linked back to an initiative such as the labor involved in the process, materials used in production, and other expenses to complete the work.
- Indirect costs: Most projects have indirect business-related costs that may not seem obvious but are still additional costs that increase with each new project. For example, electricity, rent, utilities, and other overhead costs.
- Intangible costs: Project costs are not always monetary, and the intangible costs need to be analyzed as well. Examples of intangible costs are the cost of manufacturing delays, process or strategy changes, and even cultural changes.
- Alternative costs: Deciding whether to buy it or build is a way to examine alternative costs and involves evaluating whether buying something is a more- or less-expensive option.
2. Analyze potential risks and impacts
Even when the project’s benefits outweigh the costs, it is essential toidentify, analyze, and weigh any risks. Before starting a project, recognize that with new projects come new risks. Risk factors can affect the entire business, not just the project being considered, creating a long-lasting issue.
3. Evaluate the cost-benefit analysis
After identifying and analyzing each cost, benefit, risk, and goal, it is important to evaluate the project as a whole to determine how it affects the business in general. This will help you decide if the benefits outweigh the costs and if the return on investment (ROI) over the relevant period of time is worthwhile.
Factoring in all of the cost types, risks, and completing a thorough cost-benefit evaluation can save your business a significant amount of money, resources, and discomfort in the short- and long-term.