Cost/benefit analysis
The Term Cost/Benefit (C/B) analysis is used, widely, for planning, decision support, program evaluation, proposal evaluation, and other purposes, in organizations of all kinds, even though the term itself has no precise definition beyond the implication that both positive and negative impacts are going to be summarized and weighed against each other. Some key points to remember about C/B analysis include the following:
- A good cost/benefit analysis for a major acquisition or action will include a time dimension and other characteristics of a good business case. In order to evaluate a C/B analysis properly, your audience needs to see the timing of expected inflows and outflows as well as the cost and benefit models that determine what is included in the case and what is not.
- A cost/benefit analysis will on the one hand attempt to quantify every benefit and cost for inclusion in the financial analysis, even the so-called intangible or "soft" costs and benefits. On the other hand, it will not omit discussion of important non-quantified benefits and costs. The reason it is important to quantify everything possible is this: If no financial value is assigned to an agreed cost or benefit, that impact contributes exactly nothing to the financial analysis. Is this really appropriate? Often it is not. A company may invest in technology in order to improve it’s "professional image," improve customer satisfaction, or create a "more professional work environment." But how many dollars credit do these benefits deserve? They will be valued at $0 if an acceptable valuation is not agreed.
- Cost/benefit analyses usually represent incremental costs and benefits (only financial changes due specifically to the action or proposal in view). This is because C/B analysis is usually undertaken for decision support purposes. The objective, after all, is to understand the net effect of a decision. A very easy mistake for C/B analysts to make, however, is to mix incremental C/B data with total C/B data in the same analysis.
- The most useful financial results in a C/B analysis appear in a time-based cash flow summary. This is the basis for calculating standard financial metrics such as net cash flow, DCF, IRR, and Payback Period . For this reason, C/B analyses are usually broader in scope than a return on investment (ROI) analysis, which often implies focus on a single return measure. If the cash flow statement also shows individual cost and benefit line items, it can serve as an effective tool for risk management and for optimizing returns.
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