Hey guys. 🙂 So, in this article, I will talk about Cost benefit analysis(CBA). Let me start with a simple example, and then I will move into details.
Example: Say suppose, there is a person named A. So, now, A wants to start a business of selling Rugs. Now, when this person starts his business, he will need to invest some amount which is his investment amount. He spent 1000$ on starting his business. Now, no one will just want to invest money, without knowing the benefits he will get in the future.
So, now comes the benefits analysis of our cost, i.e., the money which we are investing in the initial cost. The role of cost benefit analysis is that you will get an appropriate idea of your future benefits. The analysis will bring out ways to seek benefits in the future.
If A invested 1000$, then he must have analyzed at first hand, that what benefits he will get in future and how? If one rug he bought at 50$, then he might sell that at 60$ or even more, according to the plan made after cost benefit analyses. So, this is what the cost benefit analysis does. Hope this example worked. 🙂
So, now let’s move on the details. Following are the points which I will cover in this article:
- What is Cost Benefit Analysis?
- Process of doing a Cost Benefit Analysis
- History of CBA in US
- limitations of Cost Benefit Analysis
So, here it goes. Let’s begin.
What is Cost Benefit Analysis?
Cost benefit analysis(CBA) also known as, benefit-cost analysis(BCA), is an organized manner to calculate the strengths and weaknesses of different transactions, project investments, etc. It is used to identify options which provide the best approach, to gain benefits and at the same time, preserve savings. CBA is also described as an organized process for calculating and comparing benefits and costs of a decision, project or policy.
A cost benefit analysis is a way to analyze business decisions. You understand it in this way that the benefits from a particular business are calculated, and then the costs related to it are subtracted.
CBA(Cost Benefit Analysis) main purposes:
- To identify, whether the investment decision is correct or not. To justify and to check its feasibility. CBA checks whether the benefits will be more than the initial invested cost or not and by how much?
- To compare the projects initial cost with the future benefits. It includes expected cost and expected benefits.
- CBA aims to provide a correct decision with proper information, to lead a beneficial path.
- To make quick and simple financial decisions.
- To bring perfection in social welfare and economic efficiency.
CBA talks in monetary terms. It keeps a check that the flow of benefits and flow of project costs over time is maintained on a regular basis. There may be some similarities informal techniques of CBA with some other analytical terms which include: Cost-effectiveness analysis, cost-utility analysis, risk-benefit analysis, social return on investment(SROI)analysis, etc. All these terms are nearly related to cost, and it’s benefits analysis in one or another way.
If you are a decision maker, then CBA is very useful for you as it:
- provides you with both quantitative and qualitative information about the effects of regulation.
- surveys the effect of regulatory proposals in a standard manner. This promotes comparability, helps in the assessment of relative priority and encourages ethical decision making.
- encourages you to take charge of all the positive and negative effects of the proposed regulation. It also discourages you to make decisions based only on the impacts, on a single group within the community.
- look at different linkages between the regulatory proposal and other sectors of the economy. It also helps you maximise net benefits to society.
- helps you in finding out cost-effective solutions to various problems by identifying and measuring all costs.
- help you in making precise and transparent assumptions and judgments, even when it is difficult to calculate some costs or benefits.
- provides perfection in terms of economic efficiency. Provides well educated estimate of the best alternative.
Process of doing a Cost benefit analysis
Cost benefit analysis is a simple way of weighing up project costs and its benefits. It is to determine whether to go ahead with a particular project or not?
CBA can be performed regarding many different situations like:
- If you want to add on a new department, which also requires hiring of new employees.
- To determine the practicality of a capital purchase.
- Look upon a new project or a big change.
Steps to do a Cost Benefit Analysis(CBA)
So, let’s move on to the details. These steps will surely help you with your cost benefit analysis.
Step 1: Analyse Costs and Benefits
- The first step is to analyze all the costs related to your project. Make a list of all those costs.
- Then, analyze all the profits which are associated with your project
- It happens, that there may be some unexpected costs or benefits that you might not have predicted earlier. So, when you sit to calculate the costs and benefits, then think about the lifetime of those costs and benefits. You should know how these costs and benefits may change with time?
Step 2: Give a monetary value to the costs
- Costs includes: Cost of required physical resources and the cost of the human effort included in all phases of a project.
- Run your mind and think of as many costs as you can. Example: For a Rugs shop to run, you need to purchase rugs, hire people to work at your shop and then there are costs regarding their work at the shop and many such other present and future costs too.
- Remember, not to forget any cost. Think of long life of your project and then work accordingly. You might have to add more people to your team or bring some new technology into your business with time. So, you need to be prepared earlier only regarding the costs.
Step 3: Give a monetary value to the benefits
- So, it becomes a bit difficult to calculate the value of the benefits you may gain regarding your business.
- Things which you predict and the benefits which you calculate are soft benefits as predictions may change with near-future changes. This might include: what is the impact on the environment? Employee satisfaction or even health and safety issues. What is the monetary value of these impacts?
- Example: What is the safe and stress free, travel cost of your employees? This may change accordingly. Here, you need to consult with other stakeholders and then decide how you will handle these changing items. Keep yourself updated all the time.
Step 4: Compare your Costs and Benefits
- This is the final step. Contrast the value of your costs to the value of your benefits and then decide, what actions you need to take.
- Calculate both values of costs and benefits separately and then check whether the value of benefits is greater than that of costs or not
- Analyse and calculate the approximate time that your benefits will take, to repay you the initial cost back. The simple way is to just divide the total cost value by the total benefit value. This will give you the length of the payback period or time.
So, these were the steps to calculate your Cost benefit analysis. I hope you are now much more clear about the importance of CBA. Let’s now move towards evaluation.
CBA tries to measure all the positive and negative consequences of a project, that includes:
- Effects on the people dealing with it.
- Effects on the people who are not directly involved with it.
- Outside effects.
- Option value or other social gains.
There can be a diverse no. of Costs and benefits. Financial costs are represented briefly in cost benefit analyses. It is due to larger market data. The net benefits may include cost savings or public willingness to pay compensation or willingness to accept it. It is for the welfare changes from the policy.
The principal which guides you here is, to list all the categories of parties affected by an external mean and then add the positive or negative value. Surveys or market behavior are often used to calculate the compensation associated with a policy. People make market choices among few items that have different aspects related to the environment. They, then reveal the value they keep on these environmental factors.
One controversy which occurs is, valuing a human life. For example, when recognizing road safety measures or life safety measures. However, this situation sometimes gets avoided with cost-utility analysis. Again, for example, road safety gets measured regarding cost per life saved, without just formally placing a financial value on the life.
Another controversy is to value the environment which in today’s date means valuing ecosystem services. This includes air and water quality and pollution. Monetary values may also be given to other changing effects like business reputation, market penetration, etc.
History of CBA in US
In the 1980’s, some academic and institutional critiques of CBA started to emerge. The main three critiques were:
- CBA could be used for political goals. Discussions can be used on the merits of cost and benefit, to step aside political or philosophical goals, rules and regulations.
- CBA is anti-regulatory, therefore it’s not a neutral analysis tool.
- The time which is necessary to complete CBA, can create some delays, which can hinder policy regulations.
These critiques continued through 1990’s. Then they got reduced slowly. The main argument was that CBA should play no part in the regulatory process. But, the use of CBA continued after that too. It was due to the debate over its practicality and objective values. Some analysts still oppose the use of CBA in policy making, but most of them are in favour of its use.
Limitations of Cost Benefit Analysis
For projects that have small to mid-level capital and are running short of time, then CBA will be sufficient enough to make a detailed decision. But, for a very large project with a longer time period, CBA fails to see into important financial concerns. It includes interest rates, varying cash flows, inflation and the present value of money.
- Cost benefit analysis(CBA) is a straightforward tool to decide whether you should pursue a project or not.
- First, list down all the costs related to the project and then calculate the benefits that you will receive from it.
- Work on the time in which the benefits will repay you your initial cost.
- You can carry out a whole analysis by only using financial costs and benefits. You may also include items which change over time.
So, guys, this was all about Cost benefit analysis. I hope you liked this information and if you did, then do subscribe to my Blog. 🙂 Also, do let me know your views in the comment section below. For any query regarding this topic, or any online assignment help, you can email us on the id given on our website.
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Thank you for reading. 🙂