There are many ways to define a cost/benefit analysis, and the definitions can quickly get complicated. So to keep it simple:
"A cost benefits analysis is a process through which business decisions are analyzed. The benefits of a given situation or business-related action are summed, and then the costs associated with taking that action are subtracted."
An example: The benefits
Let's take a look at this concept within the context of a hypothetical IT project. Say you want to streamline your finance department's monthly close cycle. You estimate that by integrating stand-alone systems in purchasing, finance, and other areas of the company, and by introducing IT automation and business process redesigns into the month-end close process, you can save finance two days each month in a monthly close that now takes a total of three days monthly with every person in finance working on it.
The benefit from this system upgrade project is that finance gets its entire staff freed up from work for the two days that are saved from the close. This savings can be tabulated by adding together the daily compensation figures for all the employees who are involved in the close. The freed-up person power can be redeployed in other activities that may return more value to the business.
You also work with finance and discover that accounts receivable will be modernized, so you will be able to receive and process payments from customers sooner. This helps company revenues and cash flows, thereby reducing the amount of money (with interest) that the company needs to borrow to sustain itself while waiting for payments to clear. You work with finance to come up with a savings figure.
You add to this the cost savings the company will see from the de-implementation of legacy system hardware, software, data center expenses, etc., that are now used for the month-end close and that will be eliminated.
Hypothetically, we'll say that you project a savings of $1,000,000 per year.
SEE: Special report: Tech budgets 2018: A CXO's guide (TechRepublic PDF)
An example: The costs
Now, let's look at the flip side of the ledger—which consists of the costs of the project.
To install new systems that can facilitate faster month-end closes, you estimate hardware, software, and data center costs, amortized over the course of a five-year license. In addition, you will need to commit 10 IT staff full time for one month to complete the integration work required for the new systems. Then, there are training needs on new systems and business processes required for IT and finance personnel, and perhaps for individuals in departments who will be affected by changes in business processes. There might even be costs of notifying customers and business partners of changes—and certainly some money set aside for legal and compliance reviews.
Again hypothetically, we'll say that all this adds up to $4,000,000.
You compute your figures, and you enter the budget review process, where you go over the cost/benefit analysis—because the CEO and certainly the CFO will want to know the payback of the investment.
In our simplified example, it would appear that the break-even point for the technology investment would occur in year four. After that, there would be some ongoing costs, but the business would mostly be reaping the benefits.
Developing a cost/benefit analysis for any IT project can get interesting when costs and benefits are difficult to quantify, or when the business value of different projects have to be weighed against each other.
Calculating an IT project's costs and benefits requires expertise in planning and executing projects, developing budgets, and understanding how both costs and benefits change over the life of a technical initiative. This updated calculator provides a customizable Excel spreadsheet for collecting and calculating IT project costs and benefits. Free for Tech Pro Research subscribers.
IT managers who are tasked with these analyses can improve their results if they consider the following best practices and and are aware of certain pitfalls:
- Always evaluate any project against the priorities of other projects that are also waiting for approval and funding. Just because a project pays off faster than others, that doesn't mean it should be the first to implement. The first priority of the business is always what it needs most to stay competitive operationally and in terms of revenue.
- Don't try to do a cost/benefit analysis by yourself. There are many hidden costs that only someone in the department where the system will be deployed could know about. For this reason, it's important to have someone from that department working with you.
- Show where hard dollars are saved or earned. Soft costs are hard to quantify. I have always found it to be a hard sell when I tried to convince a CFO that so many person-hours would be saved by a new system. The reason is that there is always more work to be done elsewhere—so the company doesn't see any cost savings in its payroll.
- Check your numbers. Too many IT'ers develop cost/benefit analyses and then fail to cross-check their figures for accuracy. You don't want to go to the CFO and explain that you're going save 10 full-time employees' work for two days if you streamline the month-end close, when in reality, it might look like 10 people are working on the close, but only four of them are working full time.
The important thing to remember in a cost/benefit analysis is to keep your vision unclouded and objective—because there are many other projects competing for funding too.
Also, it's essential to know your company. Entrepreneurial companies often don't need cost/benefit analyses. If they they think a project is worthwhile and they can afford it, they just do it. In other cases, project proposals receive a great deal of scrutiny, and you'll be asked for every single number that shows that a project is a good investment.
- Business buy-in for on-demand IT (ZDNet)
- Corporate Finance 101: Equity Valuation (TechRepublic Academy)
- IT budget research 2018: Funding and spending priorities (Tech Pro Research)
- Year-round IT budget template (Tech Pro Research)
- Kanban: The benefits of using this agile PM framework (TechRepublic)
What's been your experience with conducting IT cost/benefit analyses? Share your advice with fellow TechRepublic members.
Mary E. Shacklett is president of Transworld Data, a technology research and market development firm. Prior to founding the company, Mary was Senior Vice President of Marketing and Technology at TCCU, Inc., a financial services firm; Vice President of Product Research and Software Development for Summit Information Systems, a computer software company; and Vice President of Strategic Planning and Technology at FSI International, a multinational manufacturing company in the semiconductor industry. Mary is a keynote speaker and has more than 1,000 articles, research studies, and technology publications in print.