When you are managing a project, invariably you have to weigh one option against another. A cost benefit analysis is the easiest way of comparing all your options to determine which will be the right one for your project.
What is Cost Benefit Analysis?
CBA or Cost Benefit Analysis is an efficient technique that is used to evaluate and review the benefits and costs of any given project for two reasons-first, to define the feasibility of investment; and second, to explore alternate options to accomplish the same goal.
For calculation the total expected cost of all the options is compared against the total expected benefits, to identify if the benefits are greater than the costs, and, if so, then by how much. An effective cost benefit analysis evaluates the following benefits and costs-
- Net Benefits
- Total Benefits
- Indirect cost
- Direct cost
- Opportunity cost
- Intangible cost
- Costs of potential risks.
Cost Benefit Analysis in Project Management
In project management, CBA is used to evaluate the cost vis-à-vis the benefits in your business case and project proposal.
To begin with CBA, a list of all project expenses and what are the expected benefits once the project is successfully executed is made. One can calculate CBR (cost-benefit ratio), ROI (return on investment), IRR (internal rate of return), NPV (net present value), and PBP (Payback period) from this list.
Whether the benefits are greater than costs will decide if action is necessary or not. In most cases, if the cost is 50% of the benefits and the PBP is not more than a year, then it is worth taking the action.
How to do a cost benefit analysis?
Cost Benefit Process has evolved with time. Here is the checklist to perform CBA-
- What are the goals and purposes of the project? -You will have to create a business case for your project and define its objectives and goals.
- What are the alternatives? – Before you go ahead with your project, you need to compare it with similar past projects to choose the best way forward. You can do a quick review of its success metrics such as ROI, IRR, PBP, and cost-benefit ratio.
- Who are the stakeholders? – You need to make a list of all stakeholders and identify the decision makers from that list.
- In what manner will you measure cost and benefits– You need to decide on the metrics that you will use to measure the benefits and costs
- What is the outcome of benefits and costs? – Assign a monetary value to the benefits and costs of the project and map them over a relevant period. It is vital to know that cost benefit analysis estimates the monetary value of both future and present costs and benefits.
- What is common currency?– Since you can’t compare the present monetary value of benefits and costs with the future rates, you will have to calculate the discount rate, the time value of the discount rate, and the net current value of cash flows.
- What is the discount rate? – It is the rate that is used to calculate the present value of the future cash flows of your project.
- What is Sensitivity Analysis? – It is a probability method which is used in business and management to identify how uncertainty affects decisions, benefits, and costs.
- What is your project’s NPV (net present value)?– It is the measurement of profit that is calculated by deducting the current values of cash outflows from the current values of cash inflows over a period.
- What do you do once your cost benefit analysis is complete? – The final step is to make the choice that is recommended by CBA once you have all the data.
Why Cost Benefit Analysis is vital for supply chain management?
Cost Benefit Analysis helps in choosing the best approach and evaluates the monetary and quantitative impact. CBA helps the management to gain knowledge about the pricing strategies and their impact on the supply chain, therefore, helping build robust supplier relationships while driving profitability.
For instance- The Covid-19 pandemic has exposed the lack of visibility of many companies into their offshore manufacturers and suppliers. Thus, leading to a call for better supply chain traceability and resilience. This has led many businesses to consider moving parts of their supply chain to local regions. In such a scenario business will have to perform a Cost Benefit Analysis of localizing the supply chain taking into consideration the potential barriers for relocation and way forward while comparing the benefits vs costs of both onshore and offshore.
CBA simplifies complex business decisions and provides a basis for rational comparison. Therefore, the analysis should be kept as comprehensive as possible as it reflects the interest of all the stakeholders.