How to do Cost Analysis with 7 Steps - Performing A Cost-Benefit Analysis

A cost analysis (also called cost-benefit analysis, or CBA) is a detailed outline of the potential risks and gains of a projected venture. A CBA is useful for making many types of business and personal decisions, especially ones with a potential for profit. Although conducting a CBA can be a complex task, you do not need to be a business major to learn how to do so. Anyone who's willing to brainstorm, research, and analyze data can make a top-quality CBA.

Define your CBA's unit of cost. Since a CBA's aim is to determine whether a certain project or venture is worth the cost it would take to enact, it's important to establish what exactly your CBA measures in terms of "cost" at the outset. Usually, a CBA measures literal cost in terms of money, but, in cases where money is not an issue, CBAs can measure cost in terms of time, energy usage, and more.

Itemize the tangible costs of the intended project. Almost any project comes with costs. For instance, business ventures require initial monetary investments to buy goods and supplies, train staff, and the like. The first step of a CBA is to make a thorough, exhaustive, itemized list of these costs. You may want to investigate similar projects to find costs to include on your list that you may not otherwise have considered. Costs can be one-time events or ongoing expenses. Costs should be based on actual market prices and/or research when possible, but should be intelligent, researched estimates when this is not possible.

Below are the types of costs you'll want to include in your CBA:
  1. The price of goods or equipment associated with the venture
  2. Shipping, handling, and transportation costs
  3. Operating expenses
  4. Staffing costs (wages, training, etc.)
  5. Real estate (rented offices, etc.)
  6. Insurance and taxes.
  7. Utilities (electricity, water, etc.)

Itemize any and all intangible costs. It is rare for a project's costs solely to be composed of tangible, real expenses. Usually, CBAs also take into account a project's intangible demands - things like the time and energy required to complete the project. Though these things can't actually be bought and sold, real-world costs can be assigned to them by determining the amount of money one would hypothetically be able to make if they were used for another purpose. For instance, though taking a year off from a job to write a novel is technically free, one must take into account the fact that doing so means going without wages for a year. Thus, in such a situation, we're basically exchanging money for time, buying a year for ourselves at the price of a year's wages.

Below are the types of intangible costs you'll want to consider for your CBA:
  1. The cost of the time spent on a project - i.e., the money that could be made if this time was spent doing something else
  2. The cost of the energy spent on a project
  3. The cost of adjusting an established routine
  4. The cost of any possible lost business during the implementation of the projected venture
  5. The risk factor value of intangibles like safety and customer loyalty

Itemize the projected benefits. The purpose of any CBA is to compare the benefits of a project to the costs - if the former clearly outweigh the latter, the project will probably be given the go-ahead. Itemizing the benefits is done in the same way as the cost portion of the analysis, though you will most likely need to rely on educated estimates more than you will with the costs. Try to back up your estimates with evidence from research or similar projects and assign a monetary amount to any tangible or intangible ways in which you will see a positive return on your venture.

Below are the types of benefits you'll want to consider in your CBA:
  1. Income produced
  2. Money saved
  3. Interest accrued
  4. Equity built
  5. Time and effort saved
  6. Repeat customer business
  7. Intangibles like referrals, customer satisfaction, happier employees, a safer workplace, etc.

Add up and compare the project's costs and benefits. This is the crux of any CBA. Finally, we determine whether the benefits of our project outweigh the costs. Subtract the ongoing costs from the ongoing benefits, then add up all the one-time costs to get a sense of the size of the initial investment needed to start the project. Using this information, you should be able to determine whether a project is profitable and feasible.

Calculate a payback time for the venture. The quicker a project can pay for itself, the better. Taking the cost and benefit totals into account, determine the amount of time it will take to recoup the projected costs of your initial investment. In other words, divide the cost of your initial investment by the projected income per day, week, month, etc. to determine how many days, weeks, months, etc. it will take to pay back your initial investment and start generating profit.

Use your CBA to inform your decision about whether to pursue your project. If the projected benefits of your venture clearly outweigh the costs and the project can pay for its initial investment in a reasonable amount of time, you may want to consider putting your project into action. However, if it's not clear that a project can generate additional profit in the long run or pay for itself in a reasonable amount of time, you will probably want to reconsider the project or even scrap it all together.



Post a comment