How to Do Simple Cost Benefit Analysis.

Cost benefit analysis is one of the ways business decision makers can avoid making poor strategic decisions in an unforgiving economic climate. Learning to do a simple cost benefit analysis allows business leaders to decide whether making a capital investment or failure to make that capital investment represents more risk to the company.

The key to executing a correct cost benefit analysis is rooted in quantifying foreseeable cost as well as the expected quantifiable positive cash flow over a set period of time. These costs include "hard costs" (actual dollars spent) and "soft costs" (indirect dollars spent in other areas to support a change in business model, equipment or practices).

Preparation

Even if you are the decision maker, you may not be the right person to estimate financial impact on every effected business unit. Consider building a team to do your cost benefit analysis. Assemble a business unit subject matter expert group to brainstorm potential costs and benefits of the change under consideration.

Step One: Calculate All-Inclusive Cost

It is critical for managers to calculate an all-inclusive cost for project analysis. These costs include, but should not be limited to:

Direct Costs

  • Actual capital investment
  • Any change in tax or licensing costs
  • Consulting fees (if applicable)
  • Subscription fees
  • Annual Maintenance Costs

Indirect Costs

  • Initial and ongoing training
  • Changes in space or facility requirements (leasing costs)
  • Labor hours for implementation
  • Changes in utilities rates or transportation costs
  • Other downstream or cross-unit costs

These costs should be calculated at current rates plus projected inflation/expansion costs and collated into a simple cost benefit analysis template.

Step Two: Calculate Benefits

Similar to the cost calculation, it is critical to be all inclusive in your approach to project benefits. A solid cost benefit analysis with a positive material return provides a Return on Investment (ROI) period. Some types of benefits are harder to quantify than others.

Some examples of benefits may be:

  • Increased output
  • Reduced inventory costs
  • Reduced labor cost
  • Reduced supply chain costs
  • Reduced taxes or fees

Step Three: Incorporate Time to the Equation

Cash flow is king in today’s business world. The key is collecting the discrete cost and benefit numbers, then place it in a template, generally in a spreadsheet such as Microsoft Excel, and determine the net result on cash flow over time.

In Summary
The most manageable way to complete your cost benefit analysis on a project is to use a simple cost benefit analysis template. Some of these models just have cumulative cost and savings/increased revenue for the period of ROI under consideration. Others include the "buckets" or itemize the areas that will experience significant cost or benefit over time.

The most complete will incorporate a full 10-year model to accommodate the depreciation/amortization schedule of a capital investment, even if the horizon for the ROI is much shorter than 10 year.

Whichever model you choose, the key is doing the right preparation to ensure the numbers feeding your analysis bear a strong resemblance to actual cost.

 

Return from Cost Benefit Analysis to Strategic Cost Management

Return from Cost Benefit Analysis to Purchasing Procurement Center Homepage




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