How to Do a Preliminary Cost vs. Benefit Analysis
Virtually every business decision requires some comparison of costs and benefits. A cost-benefit analysis is a technique that can help any business owner make informed financial decisions. It compares the costs associated with a project with the benefits provided by that product. Completing a preliminary cost-benefit analysis is very similar to doing it at any other time. The main difference is that you may have to estimate many of the numbers in your analysis instead of having real data.
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Instructions
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Estimate the Costs
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Create a list of all of the direct costs that you believe will be associated with the project. These costs can include project/product design, manufacturing, payroll, marketing, packaging, travel and any another expenses that may be incurred. Assign a dollar value to each cost. Because this is a preliminary cost-benefit analysis, you may have to estimate each cost on your list.
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Make a list of all of the indirect costs involved in your project. An indirect cost is not easily quantified. Time, lower production levels, and additional utility usage due to the project are all examples of indirect costs. Assign an estimated dollar value to each of these costs.
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Add the costs of each list together to determine your estimated costs.
Estimate the Benefits
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Build a list of the anticipated benefits of the project. These benefits can include increased sales and production efficiencies that result in higher profit margins. Estimate the dollar value of each of the benefits on your list.
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List each of the indirect benefits associated with the project. These benefits may include a wider distribution of your product, a more-satisfied customer base, increased product performance, a better reputation and lower utility costs. Assign a dollar value to each of these benefits.
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Add up the forecasted benefits from each list together to calculate your total benefit amount.
Compare, Analyze, Decide
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To complete a simple cost-benefit analysis, compare the total costs of your lists to total benefits of your lists. If you would like to complete a more advanced analysis, you may want to convert any future costs and benefits on your lists into net present value. This compares the value of money today to the value of the same money in the future. The formula to calculate net present value is NPV = F (1/(1+I)^n). In this formula, NPV equals net present value, F equals the estimated future value received, I equals the interest rate per time period and n equals the number of payments per time period.
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Analyze the results. If the dollar value of benefits are clearly greater than the costs, then the project should be strongly considered. If the value of the costs and benefits are near equal, then you may want to analyze all of your estimations and assumptions to ensure that your projections are correct. If the costs are higher than the benefits, then the project most likely should not move forward.
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Decide on a course of action. After analyzing all of the data in your cost-benefit analysis, you should be ready to decide whether to move forward with the project or to discard the project altogether.
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Tips & Warnings
If you find it difficult to estimate realistic values for the costs and benefits, consider searching the Internet for studies related to your product or service or contacting a trade group within your industry. Both of these options may be able to provide you with valuable information to better estimate your costs and benefits.
Include as many costs and benefits as possible. The more data you use in a cost-benefit analysis, the more accurate it is.
