Pros and Cons of Cost-Benefit Analysis

Cost-benefit analyses can also consider intangibles, such as employee morale and customer satisfaction.

FREMONT, CA: A cost-benefit analysis is a method corporations choose which options to pursue and which to forego. The cost-benefit analyst adds up the potential rewards anticipated from a scenario or action and subtracts the overall expenses involved with carrying out that activity. Some consultants and analysts develop models to quantify intangible items, such as the advantages and disadvantages of residing in a particular city.

Before constructing a new factory or undertaking a new project, sensible managers do a cost-benefit analysis to examine the potential costs and income the project could yield. The analysis outcome will determine whether the project is financially viable and whether or not the company should pursue a different initiative.

In numerous models, a cost-benefit analysis will additionally consider the opportunity cost while making a decision. Opportunity costs are advantages that could have been obtained had a different option been chosen. An opportunity cost is an opportunity loss resulting from a decision or option.

Including opportunity costs in a cost-benefit analysis enables project managers to evaluate the benefits of other courses of action in addition to the current path or option under consideration. The cost-benefit analysis is complete and facilitates better decision-making when all possibilities and potential missed opportunities are included.

Finally, it is necessary to quantitatively analyze aggregate costs and benefits results to assess whether the benefits outweigh the expenses. If so, the prudent course of action is to proceed with the project. For a profitably completed project, the firm should reevaluate the project to see if improvements can be made to raise benefits or reduce expenses. If not, the business should likely shun the project.

Benefits Of A Cost-Benefit Analysis

There are numerous reasons to do a cost-benefit analysis. The technique relies on data-driven decision-making; all advised outcomes are based on quantifiable facts acquired for a specific problem.

A cost-benefit analysis necessitates extensive investigation into all forms of costs, and this requires a consideration of unpredictability and knowledge of expense types and characteristics. This degree of analysis improves the findings as an additional study is conducted on the project's outcome stage, enhancing strategic planning efforts.

Non-financial measures must also be quantified for cost-benefit analysis (e.g., what is the financial value of improved employee satisfaction?). Although this may be tough to evaluate, it compels the analyst to investigate more challenging parts of the project. The outcome of a cost-benefit analysis is delivering a report that simplifies decision-making.

Disadvantages Of A Cost-Benefit Analysis

An in-depth cost-benefit analysis may be sufficient for making a well-informed, logical decision about projects involving minor to moderate capital expenditures and short to intermediate completion times. The present value of money, fluctuating cash flows, and inflation may be overlooked in a cost-benefit analysis for large projects with a long-term horizon.

Considering an alternative rate of return that could have been received if the project had never been completed is one of the benefits of using net present value while deciding on a project. This return is subtracted from the outcomes. In other words, the project's rate of return must be greater than the alternative rate of return or the discount rate.

Regardless of the sort of model used to perform a cost-benefit analysis, a considerable number of forecasts are incorporated into the models. The projections utilized in a cost-benefit analysis may include future income or sales, alternative rates of return, anticipated costs, and anticipated future cash flows. If one or two of the forecasts are inaccurate, the cost-benefit analysis results will certainly be questioned, underlining the limits of completing a cost-benefit analysis.