A Cost-Benefit Analysis
According to Entrepreneur Magazine, cost-benefit analysis is an approach to compare costs against expected benefits to determine the optimum action. A simple way to perform a basic cost-benefit analysis is to draw a line down a page and on the right side list all of the benefits and on the left side all the costs. Then add up all the costs and all the benefits and determine which is more.
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History
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According to San Jose State University, the concept of economic accounting originated with Jules Dupuit, an engineer from France, in 1848. Early in the 20th century, a British economic, Alfred Marshall, developed the key concepts that were the cornerstones for cost-benefit analysis. The focus on cost-benefit analysis originated from the fact that the Federal Navigation Act of 1936 specified that the U.S. Corps of Engineers only proceed with a project when the resulting benefit from a project exceeded the costs. The original methods of cost-benefit analysis were further refined and codified in the 1950s, according to San Jose State University.
Example
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One example of a cost-benefit analysis is a company that is investigating software to control its inventory management function. In analyzing this, the company would consider such costs as the software price, the costs of internal staff and consultants to install the system, and the training costs to help personnel learn how to use the system.
Some of the benefits would include reduction in carrying costs by maintaining too much inventory, improved process for managing inventory such as laying out the warehouse so materials can be moved and loaded on trucks in the most efficient manner, and improved warehouse staff morale because of better support of the inventory management function.
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Tips
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According to the New Zealand Treasury, when performing a cost-benefit analysis, make sure all the costs and benefits are included. Also make sure you have excluded interest payments and borrowed capital.
Warnings
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According to the site 12 Manage, one potential mistake with cost-benefit analysis is not considering the time value of money. To avoid this problem, the site recommends a net present value approach. According to the Agricultural Marketing Resource Center, net present value is the present value of a series of future net cash flows that will result from an investment, minus the amount of the original investment.
One problem with cost-benefit analysis is that some of the benefits from an investment are difficult to quantify.
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References
Resources
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