How to Develop a Cost-Benefit Analysis

Decide if a product or service your company receives or provides is worthwhile by conducting a cost-benefit analysis. Although it may sound complicated, a cost-benefit analysis is a fairly simple tool to use when making important business or personal financial decisions. Here are steps for doing a cost-benefit analysis.

Instructions

1. Determine and define your objectives. A cost-benefit analysis must include project objectives and background information so the reviewer can understand the information even if not intimately familiar with the industry.

2. Document the product or service's current process. All reviewers involved in the cost-benefit analysis need to understand the details of the current work processes so they can make the best decision regarding an alternative. Include information about customer service, current system capabilities and the makeup of the current system.

3. Estimate future requirements and upgrades. Talk with those inside your company or professionals outside your company to find the most realistic estimate.

4. Collect as much detailed cost data for each alternative considered as possible.

5. Choose at least three alternatives. Document and justify your assumptions for each of the alternatives.

6. Estimate the costs involved and determine a total cost.

7. Identify and estimate the value of the benefits.

8. Discount the costs and benefits. Convert the estimates into a common measurement. Calculate the present value, or the discounted value, of a future amount with the following formula: P = F (1/(1+I)n), where P = Present Value, F = Future Value, I = Interest Rate and n = number of years.

9. Evaluate the alternatives by comparing and ranking the discounted value of each alternative.

10. Perform a sensibility analysis to ensure that the results of your cost-benefit analysis are reliable.