Cost-benefit analysis is a tool project managers use to compare various business initiatives and make a financially-sound plan of action. This decision-making process has 10 total steps plus a little bit of math. We’ll walk you through these and provide the answers to some frequently asked questions about how to do a cost-benefit analysis. Then, we’ll discuss the accuracy of your findings with tools such as Wrike Analyze.
What is the purpose of cost-benefit analysis?
Performing a cost-benefit analysis can serve a few purposes — two examples being to determine the viability of a project or to decipher what can be gained financially from an investment.
Occasionally, a company may have multiple investment or project opportunities to consider, so being able to critically assess these options can help businesses make wise financial choices. You can use your findings to draft an actionable proposal that maximizes ROI and strategically utilizes available resources. It’s best for fast and simple informed decisions.
Advantages and disadvantages of a cost-benefit analysis?
A cost-benefit analysis is generally considered to be accurate for short term projects. It’s widely used across all industries to determine funding and budgeting.
Some disadvantages of a cost-benefit analysis include potential inaccuracies plus the subjectivity of non-monetary costs and benefits. Also, it’s easy to confuse a cost-benefit analysis for a project budget. A cost-benefit analysis uses estimated costs while a project budget should portray actual costs.
What are the cost-benefit analysis steps?
Here’s how to do a cost-benefit analysis and come up with a plan of action. Use Wrike’s project management tool to gather relevant information, organize your findings, and calculate your final answer.
- Write a project overview. Briefly summarize what the project is, why it’s important, and when it needs to be completed.
- Include alternatives. If your cost-benefit analysis proves the project isn’t viable in its current iteration, what are your initial ideas for other options? Keep these general descriptions in mind or refer back to them in later steps.
- Create a rating system. Use it to rank the value of costs and benefits in later steps. Doing so will make it easier to communicate your findings with team members and standardize your process for future cost-benefit analyses.
- Add up costs. Cost management in project management is not to be overlooked. Use the information you have available to add up all of your capital, labor (for both in-house teams and contractors), and ongoing expenses. Also, estimate non-monetary costs such as employee culture or any current work from home staffers.
Here are some important categories to consider:
- Principal costs such as initial software or machinery investments.
- Personnel costs which cover in-house team labor and freelance consultants with specialized skills.
- Direct and indirect costs that include things like water and power for office buildings.
- Depreciation for items such as physical equipment that loses its value over time.
- Annual costs for yearly memberships, maintenance, and taxes.
- List benefits. Consider both the implicit and explicit value of all your above costs. Note which costs provide higher ROI and use that information to improve future projects. Begin to brainstorm ideas for how you’ll either continue or change your course of action in the future.
Include each of the following categories in your analysis:
- Revenue both in the short term and long term.
- Increased efficiency and productivity that will streamline resources over time.
- Customer loyalty which directly affects long term project viability.
- Make a chart that summarizes available options. On the left-hand side of your chart, include a costs section. List all anticipated expense categories for that item underneath. Under that, include a benefits section. Write down all anticipated benefits categories.
Then, at the top of each following column, list one possible option. Fill in the spaces for each anticipated cost and benefit number underneath that project option.
Or, swap a manual chart for a Gantt chart for more useful features such as document collaboration and data visualization.
- Draft a timeline. Figure out how much you’ll need to spend over the course of the project as well as which benefits you expect to receive when. You’ll also be able to accurately estimate the time it will take to complete the project.
Use this information to calculate the Present Value of Money for anticipated costs. Remember to include inflation for long term expenses.
- Analyze possible solutions. Compare and contrast all available options for each monetary and non-monetary cost. Focus on solutions that will have a significant measurable impact using the 80/20 rule from the Pareto principle.
- Do a sensitivity analysis. Consider the anticipated increase or decrease of all stated costs and benefits over time to find solutions with the highest opportunity for success.
- Recommend a plan of action. Explain the relationship between your analysis and your recommendations.
How to do a cost-benefit analysis calculation
Use a cost-benefit analysis calculator or do the math yourself. There are lots of ways to calculate this, but we’ll show you a simple, widely used version. Plug values into this formula with data from your analysis:
(estimated sales x probability of success) / (estimated costs x probability of success)
Use a percentage from 1-100 for your probability of success numbers. Make an educated guess based on your findings from the original cost-benefit analysis. You can also use your own rating system for this step, as long as both of these numbers are weighted on the same scale.
There are more complex ways to calculate cost-benefit analysis which include factors such as inflation. However, this formula will be enough to determine project viability when paired with your written analysis.
How to evaluate your cost-benefit analysis
Evaluate your cost-benefit analysis by double-checking all assigned values and math. Have an outside eye provide feedback on some of the less definitive points such as implicit costs and your guesstimated probability of success rates. Compare past cost-benefit analyses and project outcomes or use Wrike Analyze to see where you may have fallen short in the past. Work those lessons into your next analysis to improve your accuracy over time.
Master the cost-benefit analysis calculation
A cost-benefit analysis is a useful tool for making financial decisions for short-term projects. Although it’s not a perfect system, it does make it easy to come up with a holistic evaluation of all available options. You can perfect your cost-benefit analysis skills over time with the help of a project management solution like Wrike. Start your free two-week trial today to start creating your own cost-benefit analyses.