What is meant by cost benefit analysis?
Cost benefit analysis helps businesses systematically analyze potential decisions, compare overall pros and cons, and choose to forgo or finalize certain choices. The increasing population, growing economies, and evolving industries have led to the need for data-driven, accurate, and well-informed decision-making. The process considers all the benefits and distracts all potential costs associated with deciding to determine the said project’s lifetime value, business decision, or policy. The outcome of a cost-benefit analysis enables prudent and accurate judgment regarding the efficacy of a project and helps businesses choose among various potential options. This process also ensures that companies do not struggle due to missed opportunities and successfully identify their organization’s ideal choice. A cost-benefit analysis includes direct, indirect, tangible, intangible, opportunity costs, and certain risks. The impact of an accurate cost-benefit analysis can consist of an increase in revenue and productivity, intangible benefits such as higher morale, and a significant competitive advantage due to preemptive initiatives propagated by the process.
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How do you perform a cost benefit analysis?
Set the Framework: To start right, businesses and professionals must assess the current costs, benefits, and processes in place. Cost-benefit analysis steps help gain an accurate idea of the baseline and develop a more comprehensive and precise understanding of any new project or impact of the policy. When professionals gauge the status quo, they can stipulate the organization’s changes required or current strengths and offer well-informed options for improving the business. Additionally, this step involves analyzing current alternatives of upcoming projects or policies and highlighting problem points or issues must be addressed in the cost-benefit analysis.
Specify All Options: Ensuring an accurate cost-benefit analysis requires awareness regarding all potential options and their impact on the organization or project. While identifying options, companies should also identify alternative projects and compare their options to ensure value by any new introductions. When proceeding, the clear categorization of options and division of value makes the cost-benefit analysis more accurate, clear and leads to a higher chance of finding the ideal step to be taken.
Identify & Categorize Costs & Benefits: Once the options have been selected, the next step involves identifying the impact, costs, and benefits of each potential option and alternative. Every potential impact should be categorized into costs and benefits to be later compared with each other and the baseline. All effects considered positive for the business are measured as benefits, whereas all undesirable expenses fall under losses. Additionally, this step involves selecting measurement indicators to determine the value of new projects and policies and comparing the costs and benefits with the baseline determined in this process’s first step.
Project Lifetime Costs: The costs and impacts of any project or policy are not limited to the ideation, development, and execution process. When chosen and acted on, a project will incur a variety of costs over a long period. To assess the cost benefits of any new initiative accurately, it is imperative to project potential future costs and assess expected values and variability of benefit flows. Forecasting certain factors are challenging, but the best estimates of expected costs and benefits lead to a more accurate cost-benefit analysis. This projection should include major uncertainties and their potential impact on the project or policies in the future.
Monetize Costs: Assigning a monetary value to the benefits and losses can help professionals gain a clear perspective of the actual impact of their new initiatives on the organization and other individuals or companies that will be impacted. This is important to determine whether the various options will leave the affected people and organizations better off or worse off. Assigning a monetary value also enables resource allocation and efficiency. While certain factors and costs are difficult or uncertain to place a dollar value on, experts suggest a detailed qualitative analysis as an appropriate substitute for dollar values. It is crucial to ensure that important data and evidence accompany the monetized values and qualitative research to ensure transparency.
Obtain and Compute Net Present Values: Computing and identifying the net present value (NPV) of the project or policy comprises deducting the present value of the benefits and costs. To acquire an accurate net present value, it is imperative to discount future cash flows due to either of two reasons, consumers and people prefer a “dollar today to a dollar in the future” concept, or it is necessary to take into account the required rate of return which can be carried out in the net present value calculation. For this step, it is also important to account for inflation during the analysis. If the NPV is positive, the potential project or policy contributes to higher efficiency, whereas a negative value signifies inefficiency.
Conduct a Sensitivity Analysis: Due to the various projected, assumed, and estimated values utilized in calculating the NPV, it is necessary for companies to carry out a sensitivity analysis. This step helps determine the efficiency of the process, the accuracy of the value and highlights how sensitive the predicted benefits are to changing variables and uncertain factors. There are various types of sensitivity analyses, such as the worst/best case analysis, which compares them highly pessimistic/optimistic values with the most plausible data, and the partial sensitivity analysis, which studies the impact of one variable on the net benefits over a plausible range. If the NPV does not change from positive to negative, or vice versa, the process is accurate and can be used as a reference point.
Make the Final Call: The final step involves compiling, comparing, and analyzing the results of the cost-benefit analysis and determining the ideal option. Choosing the most efficient option is a data-driven decision that can be made accurately and easily with the cost-benefit analysis. In this step, professionals can compare the net present values, qualitative research, and projections of the stated options, make a well-informed decision, and ensure an efficient and successful project or policy. It is crucial to note that the highest NPV is not necessarily the best option, as a smaller NPV might also have lower downside risks and lesser impact on consumers or employees.
Conducting an extensive cost benefit analysis is a game-changing plan for companies to develop winning strategies. Stay ahead by requesting service on our procurement platform to gain the latest insights into cost benefit analysis solutions by SpendEdge.
The cost-benefit analysis process is long-drawn and meticulous. However, it is efficient and accurate and enables data-driven decision-making. The continuous shifting of variables and plethora of economic and business factors have made it increasingly challenging for companies to forecast the impact of their projects and policies and make beneficial and sustainable business decisions. With a cost-benefit analysis, companies can identify their options, categorize the impact, assign monetary values, project the lifetime impact of their initiatives, compute net present values, and ensure their process and calculations’ accuracy. This process’s efficiency and accuracy help companies take the right step when introducing new projects and policies, preparing for potential uncertainties, mitigating risks, and maintaining comprehensive plans. Cost-benefit analysis is a crucial tool for project managers that helps you calculate your return on investment, payback period, and net present value and choose the most beneficial projects and policies for your company.
Cost benefit analysis assists a prominent telecom conglomerate in Western Europe identify potential cost saving opportunities.
Challenge: The client, one of the leaders in telecom industry, wanted to streamline and identify their spending behavior to meet their procurement objectives. The client wanted to gain accurate, consistent, and detailed visibility into the spending patterns and improve data quality to optimize cost structure.
Benefits offered: The solution offered helped the client develop state-of-the-art tools to gain an extensive cost benefit analysis. The client was able to identify the latest cost saving opportunities in the supply chain and generate accurate and actionable insights on spend patterns.
Developing an intelligent cost structure is crucial for companies to develop effective strategies. Stay ahead by requesting service on our procurement platform to gain the latest insights into cost benefit analysis steps and examples.
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