The Principles Of Cost Benefit Analysis (COBA)
A cost-benefit analysis is a decision-making tool and therefore allows us to decide whether a project is viable or not. A cost-benefit analysis provides the payback period of the costs or investment incurred for a project.
The payback period is simply the amount of time over which the costs are paid back. This could be weeks, months or years depending on the size of the project and the costs involved.
The steps to building a cost-benefit analysis are covered on the next few pages.
Step 1 – identify the areas of cost for the project. These might include:
- people, their wages and/or their time
- physical resources such as equipment and other supplies and materials
- other costs such as overheads (lighting, heating, insurances, administration)
Step 2 – conduct research into:
- how much the resources and materials needed will cost
- how much time they will be needed for
- what alternative prices and options are available
- what existing resources could be used and any one-off purchases that need to be made
We might further seek to obtain information from others who have conducted similar projects before, or our finance/accounting team might be able to supply information to assist us.
Step 3 – estimate the costs
We compile lists of activities, resources and any purchases and build a picture of the costs involved. However there may be some aspects that require us to provide our best guess or estimate of the costs. If we do this we need to support our estimation with some rationale.
We might also consider:
- how high the costs could be
- how low they could be
- what the likely mid-point could be
We could again speak to others who have estimated similar projects before or get some advice from the finance/accounting team on our costs.
Step 4 – calculate the benefits of completing the project
We now need to consider the benefits of delivering the project. These benefits might include:
- increased sales
- increased production
- reduced costs
- reduced or eliminated maintenance/replacement parts
- improved quality of products and/or service
- taking advantage of new technology
- more efficient working practices
- reduced waste levels
- motivated workforce
- improved working environment
- customer retention and/or satisfaction
The benefits, like the costs, will often have a quantitative aspect to them, however we should consider the qualitative (non-financial) benefits for undertaking the project. We may need to estimate these and provide a clear rationale for our estimations and what assumptions we have made/what supports those assumptions.
Step 5 – compare the costs to the benefits
List all of the costs and benefits and calculate the values. Does the value of the benefits exceed the costs? Also compare the qualitative costs and benefits.
Step 6 – calculate the payback period
How long will it take to see the cost of the investment returned through the project? Of course the higher the costs the longer it will potentially take to pay back.
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