Project management ABC: C for cost-benefit analysis

The cost-benefit analysis: a comprehensive guide to decision-making

What is a cost-benefit analysis?

A cost-benefit analysis is a systematic method for evaluating the economic feasibility of a project or decision. The costs incurred are compared with the expected benefits to enable a well-founded decision to be made on which measures should be taken or pursued. The aim is to ensure that the benefits of a project exceed its costs. The CBA therefore provides a quantitative perspective on the project and enables a clear decision to be made, rather than listening to individual preferences or gut feeling. As part of the analysis, the costs and benefits of the various options are compared to calculate the net benefit of the project.

Areas of application of the cost-benefit analysis

The cost-benefit analysis is ideal for making a decision on measures where the economic costs and benefits can be expressed in monetary terms. The analysis itself can be demanding and time-consuming. It is therefore hardly worthwhile for small, less complex decisions that can be made with the help of a simple decision matrix. However, if you are faced with major decisions that can have a significant impact on the success of a project, such an analysis can be useful in the following areas, for example:

• Companies can use CBA to make investment decisions, optimize costs or decide on product developments. A cost-benefit analysis is also helpful for developing a corporate strategy.
• In project management, cost-benefit analysis can be used to evaluate project ideas or allocate resources.
• There are numerous areas of application for CBA in public administration, from infrastructure projects and social programs to environmental policy.
• In the healthcare sector, new medical treatments or drugs can be evaluated by means of a cost-benefit analysis.

Advantages of the cost-benefit analysis

• Better decision-making: Companies and organizations receive a clear basis for investments.
• Efficient use of resources: Resources are used optimally by avoiding unprofitable projects.
• Transparency and traceability: A CBA creates clarity about the economic impact of a decision.
• Comparability of different options: It makes it possible to objectively weigh up several alternatives against each other.

Carrying out a cost-benefit analysis – step by step

1. clarify the framework
First of all, the framework of the CBA should be defined. A cost-benefit analysis usually begins with a specific question that is to be answered by the analysis. For example: “Should we start project XY?”
In order to be able to identify costs and benefits in the following steps, it is also important to understand the current status or starting point. Therefore, write down a description of the current situation or performance, predicted results of the project as well as opportunities and risks. Then define the framework of the CBA. This means, for example, for what time frame the estimates of costs and benefits will apply, what type of costs and benefits will be included or excluded, and how these will be measured.

2. identification of costs and benefits
In the next step, all relevant costs and benefits are recorded. These include:

• Direct costs: These are costs incurred in the course of manufacturing the product, providing the service or implementing the project, such as acquisition costs, operating costs or personnel costs.
• Indirect costs: These are fixed costs that are not directly related to the project, such as rent, transportation costs or opportunity costs.
• Other costs: Also consider costs that cannot be measured in concrete terms or that are associated with risks. For example, effects on brand perception or customer satisfaction, costs for unused opportunities or expenses that you have to incur to prevent risks. Such costs can often be measured with the help of key figures.
• Monetary benefits: Benefits that can be measured with a specific monetary amount belong in this category. These include revenue, sales increases, savings or efficiency gains.
• Non-monetary benefits: However, there are also indirect benefits, for example through improved customer satisfaction, environmental protection or social benefits. These benefits can often be measured using key figures that you can include in the calculation.

3. estimate costs and benefits
Once the costs and benefits have been identified, they should, if possible, be expressed in monetary terms. This can be done with market data, expert opinions or statistical calculations, but also with empirical values from past projects.
As many projects have long-term effects, it is important to take time preference into account. This is done by discounting future costs and benefits using a discount rate to calculate the present value of these amounts.

4. calculation of the cost-benefit ratio
The total benefits are now compared with the total costs. A frequently used formula is:
Net benefits = total benefits – total costs
Total benefits and total costs are the sum of all benefits and costs.

5. sensitivity analysis
To check the robustness of the results, it helps to consider different scenarios, e.g. optimistic, realistic and pessimistic assumptions. This allows uncertainties to be better assessed. This is done with a sensitivity analysis, for example.

6. decision-making
A well-founded decision can be made based on the results:

• If the net benefit is positive, this means that the project has a greater benefit than the costs. This therefore speaks in favor of implementing the project. However, pay attention to how big the net benefit is. If the benefit is too small, the impact may be too small compared to the effort involved. In such cases, you should check whether there is an alternative that could achieve a better result.
• A negative benefit means that the costs of the project are greater than the benefits. If you can find a way to redesign the biggest cost items to reduce the costs, the project may still be feasible. If not, the project is not worthwhile.

Challenges and criticism of the cost-benefit analysis

Despite their advantages, there are some challenges in the cost-benefit analysis:

• Difficulty of monetization: Not all factors can be easily expressed in monetary terms (e.g. environmental or social impacts).
• Uncertainties in forecasts: Long-term estimates harbor the risk of miscalculations, as changes in the market are often unpredictable. The same applies to risks.
• Subjective assumptions: The choice of discount rate and other parameters can influence the results.

Conclusion

The cost-benefit analysis is a powerful tool for the economic evaluation of projects and investments. It provides a structured basis for decision-making and helps to better weigh up risks and opportunities. Despite some challenges, it remains an indispensable tool for companies, governments and organizations worldwide.

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