Unlocking the Secret to Success: A Complete Guide to Cost-Benefit Analysis
Although conducting a cost-benefit analysis is a complex task, it is still necessary for you to learn this technique. Anyone willing to think carefully about, collect, and analyze data can produce a top-notch cost-benefit analysis.
Identify the Cost Units for Your Cost-Benefit Analysis
Because the purpose of a cost-benefit analysis is to determine whether a particular project or activity is worth pursuing, the initial cost is important in terms of the cost-benefit analysis method you use. Generally speaking, the literal cost of cost-benefit analysis is for money. However, in some places where the monetary cost is not prominent, the cost-benefit analysis can also be used to measure time costs, energy costs, and even other costs.
- To prove this argument, let us assume a cost-benefit analysis in this article. We now assume that selling lemonade on summer weekends is profitable, and we now need to do a cost-benefit analysis to decide whether to open another sales location in another location in town. In this case, we focused on whether a hypothetical second location would make us profitable in the long term, or whether the cost of expanding sales locations would be prohibitive.
List the tangible costs of a potential project. Almost all projects incur costs. For example, business operations require initial capital costs, investments to purchase goods and raw materials, training employees, and so on. The first step in a cost-benefit analysis is to develop a thorough and detailed list of costs. It is recommended that you find the costs of relevant items so that you do not miss anything. Costs may be one-time or ongoing. When possible, costs should be based on actual market values and research, but when market values and research are not feasible, your estimates should be informed and researched.
- Prices of goods or equipment related to investment behavior
- Shipping, handling and transportation charges
- Operating expenses
- Personnel costs (salaries, training, etc.)
- Real estate expenses (renting an office, etc.)
- Insurance and taxes
- Shared expenses (electricity bill, water bill, etc.)
List All Intangible Costs
The cost of a project is rarely just the physical and real estate costs. Typically, a cost-benefit analysis will also include the intangible requirements of the project, such as time and energy. Although these things cannot be bought and sold in reality, the losses caused by using intangible resources for other purposes can still be regarded as real tangible costs. For example, if you spend an entire year writing a novel instead of working, that means you will have zero income for the year. Therefore, in this case, we are using money to buy time, using one year’s salary to buy one year’s time for use.
- The time invested in the project, i.e., the money that could be earned if that time were used elsewhere
- Energy spent on the project
- Used to formulate and adjust daily routines
- Business losses that may occur when implementing this investment behavior
- Risk factors for loss of value due to reasons such as security and employee loyalty
List the Project’s Profits
The purpose of a cost-benefit analysis is to compare the benefits and costs of the project – if the former is significantly higher than the latter, then the project is feasible. List the project’s benefits just like you list its costs, but this process will require far more professional estimates than the estimates used to calculate costs. Try to make your estimates as reasonable as possible through surveys or similar projects, and list corresponding amounts for each tangible and intangible cost so that you can visually observe the positive returns of investment behavior.
- Output income
- Money saved
- Accumulated interest
- Assets formed
- Saved time and effort
- Repeat customer business
- Intangible benefits, such as referral business, customer satisfaction, a pleasant employment relationship, a safe working environment, etc.
Add up and compare project costs and benefits. This is the core of all cost-benefit analysis. Finally, we decide whether the benefits of the project outweigh the costs. Subtract ongoing costs from ongoing benefits and then add up all one-time costs to get a rough idea of the size of the initial investment to run the project. Using information like this, you can decide whether the project will be profitable or loss-making.
Let’s compare the costs and benefits of opening a new lemonade sales station:
- Ongoing costs: 120 yuan/day (raw materials) + 240 yuan/day (wages) = 360 yuan/day.
- Continuous income: 720 yuan/day (income) + 45 yuan/day (extra half-hour income) + 15 yuan/day (save lemons) = 780 yuan/day.
- One-time cost: 960 yuan (loss from the original sales point being closed for one day) + 480 yuan (supply chain problems) + 480 yuan (mixer) + 90 yuan (freezer) + 120 yuan (wood, cardboard) = 2130 yuan.
- Therefore, with an initial investment of 2,130 yuan, the expected profit is 780 yuan – 360 yuan = 420 yuan/day. Looks pretty good.
Calculate the Payback Time of Investment Behavior
The shorter the payback time for a project, the better. Weigh costs and benefits together to calculate how long the initial cost will be recovered. In other words, the initial investment is allocated based on the daily, weekly and monthly income of the project to determine the timing of recovery and the point at which it can be profitable.
- The initial capital of our potential lemon juice sales station is 2130 yuan, which can make a profit of 420 yuan per day, 2130/420≈5. So we know that assuming our estimates are accurate, our new lemonade sales station can earn back the profit of 5 funds in 1 working day. Since our sales station is only open on weekends, it will take approximately 2-3 weeks to get your money back.
Utilize Cost-Benefit Analysis to Provide Recommendations
If the return on the investment project is significantly higher than the cost, and the funds for the investment project can be recovered within a reasonable period, then you will want to put the investment project into practice as soon as possible. However, if the benefits of the project are not significantly higher than the costs in the long run, or the funds cannot be recovered within a reasonable time, then you may need to reconsider the investment project or even abandon the plan entirely.
Tips
- Based on your cost-benefit analysis, our new lemonade outlets look like a done deal. The capital recovery of tone only takes a few weeks, and you will start to make profits after a certain point. Summer lasts a few months, so if we’re lucky we’ll be able to make a lot more money out of two lemonade stands this summer than a single one.
- Calculate the value of intangible assets by taking the value of the intangible asset’s costs (benefit) and statistical probabilities. For example, a customer may send you a letter of introduction, which increases your business’s net profit by $120. The probability that a client will send you such a letter of introduction is 30%. Therefore, the result obtained through cost-benefit analysis is a profit of 36 yuan.
- Each investment behavior has different costs and benefits. When listing the amounts of these items, you should be as detailed as possible, and try not to omit them. Remember that every decimal point is significant.