Importance of Cost Benefit Analysis in Decision Making for Companies

Companies often need to weigh one project against another to make business decisions. They need to evaluate all potential costs and revenues that can be generated from a project. The outcome of the analysis determines whether the revenue generated is sufficient to cover costs or the company should go for another financially feasible project. A cost benefit analysis is a methodology used by companies to estimate the likely costs and benefits of potential projects. Many companies also consider the opportunity cost into the decision making process. It helps companies to analyze alternative benefits that could have been realized when choosing one alternative over another.

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Importance of Cost Benefit Analysis in Decision Making

Simplifies complex business decisions

A cost benefit analysis template allows businesses to simplify complex business decisions. Companies might entail a variety of expenses in different types of projects at a low level. Performing cost benefit analysis allows companies to measure the benefits of a decision (benefits of taking action minus the costs associated with taking that action). It involves measurable financial metrics such as revenue earned, and costs saved as a result of the decision to pursue a project. This helps businesses to compare different projects based on net benefits irrespective of dissimilarities.

Provides a basis for rational comparison

This is one of the major benefits of performing a cost benefit analysis. With plenty of investments around, companies at times find it difficult to select the best alternative. Businesses who have invested time in projects may be predisposed to pursue those projects despite the availability of financially viable projects. Cost benefit analysis helps businesses to pick through available options, rank projects according to the order of their merit, and overcome biases for the good of the business.

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Estimates the net benefit of a project

Predicting benefits is more difficult than predicting costs. Investment opportunities are many but resources at disposal are finite. For instance, a company might estimate the production cost, but it is difficult to predict the profit margins of any new product going on the market. However, estimating costs and benefits can help businesses get an idea of the lowest revenue a new project needs to produce to ensure the profitability of the project. Being aware of the Opportunity Cost or the next best alternative can help businesses if in case the desired revenues are not produced.

Estimating the net benefit and opportunity cost of a project can help you choose a financially viable project. Request a free demo of our procurement platform to gain exclusive insights into cost benefit analysis steps.

Improves credibility by performing sensitivity analysis

Situations might vary and change the estimated outcome. Sensitivity or “what if” analysis can be instrumental in improving the credibility of a cost benefit analysis. It is predominantly used when there is ambiguity over the discount rate. Companies can re-run the analysis with the possible values to test the sensitivity of the cost benefit analysis model.

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A Comprehensive Guide to Perform Cost Benefit Analysis

Getting the most out of every idea and investment has become the necessity for businesses today. From large enterprises to startups, most companies rely on cost benefit analysis to support decision making and gain an evidence-based view of the issue being evaluated. By providing an unclouded view of the impact of a decision, cost benefit analysis enables businesses to develop a business strategy, evaluate a new hire, efficiently allocate resources, and improve purchasing decisions. Through this article, our experts highlight the key steps involved in performing the cost benefit analysis.

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Steps to Perform Cost Benefit Analysis

Cost Benefit Analysis Step #1: Establish a framework for analysis

Identify the state of affairs before and after the investment or policy change. Outline the proposed program or policy change in detail. Measure the profit of taking up any investment option as opposed to doing nothing. Sometimes the status quo is the most lucrative place for businesses to be in, but it requires identification of risks beforehand.

Cost Benefit Analysis Step #2: Analyze costs and benefits

Once the framework is established, sort costs and benefits into different categories. The primary categories associated with different categories are mentioned below.

Direct costs are often associated with the production of products or services.
Indirect costs are fixed in nature. They may either come from a cost center or department.
Tangible costs are the costs related to an identifiable asset such as payroll, rent or purchasing tools.
Intangible costs are costs pertaining to shifts in customer satisfaction, and productivity levels. Such costs and difficult to identify and measure.
Real costs are expenses that contribute to the bottom line net-benefits.

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Cost Benefit Analysis Step #3: Determine a deadline for expected cost benefits

Time is the most important element when it comes to decision making in businesses. Analyze when the costs and benefits will occur and how much. This will help you to align yourself to the expectations of all interested stakeholders. Also, the timeline will allow you to plan for the impact that the cost and revenue will have on the operations. This will empower you to manage contingencies in an effective manner.

Determining a deadline for expected cost benefits is crucial for companies to develop a contingency plan. Subscribe for a free demo to get unlimited access to SpendEdge’s insights and web-based procurement platform.

Cost Benefit Analysis Step #4: Calculate net present values

Compute return on investments by subtracting costs from benefits. Also, determine the time required for benefits to repay costs. While computing net present values or ROI, companies must estimate the situation with the project and without the project. To be specific, alternative options must be explicitly specified and considered in the evaluation of the project.

How SpendEdge Can Help You?

Performing cost benefit analysis is imperative for companies to make economically viable solutions. Costs and benefits should be precisely defined with minimal involvement of subjectivity to determine the feasibility of projects. With in-depth analysis of different procurement strategies, our experts execute a comprehensive cost-benefit analysis and provide a realistic assessment of risks and ensure that you receive the best value-for-money.

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Cost Benefit Analysis: Increasing Revenues by 30% for a Financial Services Organization

Changing regulatory requirements across the globe has compelled financial services organizations to identify their capital requirements and invest in projects that are economically viable.

The Business Problem

The client is a global financial services organization, headquartered in the US, which generates an annual revenue of $18 billion. Owing to the recent changes in regulatory policies, the client wanted to associate with organizations such as SpendEdge to leverage their expertise in devising an effective cost benefit analysis template. They wanted to minimize the undue burden on their customers and evaluate investment policies and new banking regulations to ensure financial stability. In addition, they wanted to drive effectiveness and efficiencies across their risk and compliance programs to meet applicable laws. Also, they sought to analyze investment opportunities and drive better revenues.

It is imperative for companies to analyze their projects based on actual financial costs. Request a free proposal and access our complete portfolio of cost benefit analysis solutions.

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Solutions Offered and Client Journey

The experts at SpendEdge identified the capital requirements of the client in the initial phase of the engagement and devised an effective cost benefit analysis template. They analyzed the minimum ratio of capital to assets that must be maintained to prevent the firm from becoming overleveraged. This enabled the client to minimize the risk of insolvency if asset values decline or the cost of borrowing increases.

In the next phase of the engagement, the experts mapped the time required to realize cost benefits with the ongoing policies and how much will they pan out over a phase. This helped the client to align themselves to the expectations of customers and stakeholders and understand the impact of cost and revenue. In addition, the cost benefit analysis template enabled the client to compute the net present values and ensure feasibility of policies.

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Key Findings and Outcome

Increased revenues

The cost benefit analysis template helped the client to reduce capital misallocation. They engaged resources on projects that would generate positive value for the company. In addition, limiting the number of trades that can be made over small periods of time counted in favor of the client and helped them increase revenues by over 30%.

Reduces uncertainties

The solution offered reduced uncertainties for the client. It modified the risk level for the client and helped them to develop financial capabilities to the extent that they almost became risk-averse. This protected the client from making investments based on cognitive biases and prevented them from making financial trades that undermined their financial well-being. For detailed insights on cost benefit analysis method and solution offered, request for more information.

Cost Benefit Analysis Steps

What are the Benefits of Cost Benefit Analysis Template?

Simplifies complex business process

Cost benefit analysis template simplifies complex business processes. It provides detailed insights into the different types of expenses or investments in simple terms and allows businesses to compare different projects or policies no matter how dissimilar they are.

Compares ongoing initiatives

The is another benefit of having cost benefit analysis template. It compares projects or initiatives based on actual financial costs and helps businesses overcome biases and invest in projects that are actually financially viable.

Estimates net benefit

Although companies cost benefit analysis template can estimate the net benefit of a project, but benefits are comparatively difficult to predict. Estimating costs and benefits can help businesses to calculate the lowest amount of revenue a new project needs to produce to make it profitable.

Want to know how you can conduct cost benefit analysis? Get in touch with our experts and gain detailed insights on the cost benefit analysis steps.

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4 Essential Steps for Effective Cost Benefit Analysis

For every business to succeed, it has become very crucial to get the most of every available idea, option, and investment. In order to succeed in doing so, every organization big or small leverage the aid of cost benefit analysis template. This, in turn, helps them to make wise and calculated business decisions. Cost benefit analysis template serves as a beneficial tool for procurement decision making, but its accuracy is based on its ability to recognize costs and potential benefits. This is crucial from the procurement point of view as the lack of ability to analyze costs and associated benefits will eventually lead to poor results and this, in turn, will lead to substandard decisions. By adopting the appropriate cost benefit analysis template, companies can efficiently determine the highest and best return on investment based on resources, structures of price and the associated factors of risk. But before landing on the framework of the template, let’s understand the steps in the cost benefit analysis as it the fundamental part of business decision making, across an array of disciplines. It provides several unique and valuable insights when required steps have been followed. We, at SpendEdge, have devised five essential steps that should be followed for effective cost benefit analysis: