Project management involves making a lot of decisions and these decisions cannot always be easy.
This is especially true when those decisions could potentially be critical to the success of your project overall.
These decisions, therefore, are not taken lightly. But what is a good way to be able to make such decisions and feel content with the course of action you take?
Enter cost-benefit analysis.
Cost benefit analysis allows you to choose the options that minimize risk while giving you the greatest potential benefit in the sea of options in front of you.
Using the benefit-cost analysis tool allows you to minimize risks and maximize gains giving your project the best chance of being a success.
Here is your guide to an efficient cost-benefit analysis.
What is Cost Benefit Analysis?
Cost benefit analysis is also known as benefit-cost analysis or CBA for short is a business process to help evaluate decisions.
This analysis is a process that allows you to more easily analyze decisions, projects, or systems.
You can also determine the value of intangibles.
The process involves evaluating potential costs versus potential benefits of a decision or project, comparing and evaluating the two to allow you to make a more conscious and data-driven decision.
The analysis can help you make reasonable conclusions and evaluate the feasibility or desirability of any project or decision.
History of Cost-Benefit Analysis (CBA)
The use of cost and benefit assessment is said to have been used for the first time in the 19th century by a French engineer and self-taught economist called Jules Dupuit.
Jules Dupuit used the basic principles in his job at a bridge project in helping determine tolls.
Dupuit outlined the principles behind what is now known as the cost-benefit assessment in an article that was published in 1848. His work was later worked on, defined, and then eventually popularized by Alfred Marshall in the late 1800s. Alfred Marshall was an economist and is known for his text called ‘Principles of Economics’.
Purpose of a Cost Benefit Analysis
The main purpose of a cost and benefit analysis is to help in decision-making.
This systematic approach to figuring out the positives and negatives of undertaking a project is used in multiple different disciplines.
Such analysis is used in project management, business, finance, government, and even for non-profit projects.
Cost and benefit analysis allows you to determine whether a project about to be undertaken is worth it in terms of being sound, justifiable, and feasible.
Such analysis also offers the ability to create comparisons if you have multiple projects you are considering. You can evaluate which individual project’s benefits outweigh the costs and move ahead with that one.
Other valuable insights you can gain from a cost and benefit analysis for the following:
- Quantifying effects on potential stakeholders and participants of your projects
- Weighing any social benefits that you can gain from your project
- Weighing investment opportunities to make informed decisions
- Evaluating new hires you are considering
- Assessing change initiatives
- Considering the desirability of suggested policies
Importance of Cost Analysis in Project Management
- Cost-benefit analysis assists organizations in weighing advantages and negatives in a data-driven manner so that complicated choices can be made in a methodical manner.
- Leaders must identify and project the explicit and hidden costs and benefits of a proposed action or investment for a CBA to be effective.
- It is also a good idea to delegate responsibility for making the case for the status quo as a method to evaluate the opportunity cost of doing nothing and investing funds with recommended measures.
- Because a cost-benefit analysis is only as effective as the data it is based on, organizations with more mature financial reporting have a better chance of success.
Types of Costs
When conducting a CBA you will come across different types of costs. You can categorize these costs into the following groups, that is Direct costs, Indirect costs, Intangible costs, Tangible costs, Opportunity costs, and costs of potential risks.
Let’s go over each type of cost in turn:
1. Direct Costs
You can define direct costs usually by the association of a cost object. That means costs associated with the project, product, service, customer, or activity.
2. Indirect Costs
Indirect costs are usually fixed in nature. These types of costs can occur from things such as rent, utilities, and overhead costs from management.
3. Intangible Costs
Costs that are difficult to measure or identify are known as intangible costs. These are usually more qualitative in nature rather than quantitative values such as things like productivity levels and shifts in customer satisfaction.
4. Tangible Costs
Contrary to intangible costs, tangible costs are easy to measure and quantify. Costs that are related to identifiable assets or sources like employee payroll, rent, etc come under this category.
5. Opportunity Costs
You also have those costs which can be defined as opportunity costs. These costs include things such as considering alternatives like alternative investments or building something rather than buying it.
6. Cost of Potential Risks
You also have costs that may arise due to potential risks. These could be anything from environmental impacts to regulatory risks.
It is important to understand the possible costs that may be associated with your project or activity for which you are conducting a CBA. A CBA involves compiling a list of all the costs.
Besides potential costs, you also need to consider what benefits you and your company or organization may gain.
A Brief Explanation of the Triple Constraint in Project Management
Types of Benefits
The second most important part of a CBA is the potential benefits associated with your project or activity.
Here are some of the types of benefits that you may come across when conducting a CBA for your upcoming project or when contemplating a certain decision.
- You may find that you and your company will benefit from a competitive advantage or a market share gain due to the project you undertake or the decision you make.
- You may be able to gain possible revenue and sales increases as a result of increased production or the release of a new product.
- There are also different intangible benefits you and your company or organization can gain. These include things such as improved customer satisfaction, and improved employee morale.
How to Conduct a Cost Benefit Analysis?
Here are some basic steps you can follow to help with your next CBA. Remember that this is simply a guide and how you and your team choose to specifically undertake your CBA is entirely up to you.
However, there are three basic steps to get you started.
Step #1: List Down Possible Costs and Benefits
The first step to any CBA is to brainstorm and list down any potential costs and benefits that are associated with your project or decision you are considering.
We have highlighted the different categories of costs and benefits you should consider when doing this brainstorm above.
Try to include everything and don’t miss anything out. Considering all the different costs and benefits some that may seem trivial as well still need to be included.
Step #2: Assign a Monetary Value to all the Costs and Benefits Identified
While the first step is simple brainstorming this is where it gets more quantitative and precise.
Once you have highlighted the potential costs of your project or decision it is time to assign value to the costs. Usually, costs are easy to estimate and quantify.
It is important not to forget any continuing costs that may be faced even after your project is complete or the decision you are contemplating has been taken.
Just as you have assigned a monetary value to the costs you identified you need to do the same for the benefits that you have listed down as well.
This can be comparatively more complicated and difficult than quantifying costs. Predicting potential revenue for example can be challenging.
Furthermore, the intangible benefits that are usually qualitative like increased customer satisfaction and employee morale are hard to put value to.
A possible way to overcome this is to involve stakeholders who can help decide what value to assign such benefits.
Step #3: Compare the Costs with the Benefits
As we have mentioned, CBA is the comparison between potential costs as opposed to the benefits of undertaking any project, decision, or such.
Here you will want to compare the value you assigned to your costs to that of the value of the benefits you identified.
Calculate your total costs and then your total benefits. You need to determine if your benefits outweigh the costs you have estimated.
This is not a simple case of subtraction, however. You will also want to consider the payback time.
Payback time is the time in which the benefits have repaid the costs.
You will then use this analysis to decide what your course of action will be and what is the best decision or step to take for the best possible outcome for you, your team, and your company or organization.
Cost-Benefit Analysis Precision
If you’re handling an IT project you should know how accurate Cost analysis for that IT project is? The short answer is that it can only be as accurate as the data you feed it. The more accurate your estimates, the more accurate your results.
Some errors are caused by the following factors:
- Leaning too much on data obtained from past projects, especially when those projects differ in scope
- The inappropriate use of heuristics (uncertain problem-solving approaches) to calculate the cost of intangibles.
- Confirmation bias, or using only data that support your desired conclusion
Limitations of CBA
While an effective CBA is a great tool to use and can make difficult decisions data-based and more likely to be the right choice, there are limitations to everything.
In order to make an ideal and proper decision, CBA is best suited for projects that are not too complex and are usually smaller in size.
When you use CBA on larger more complex projects the calculations can be more difficult due to varying factors. Lengthy projects are also more difficult to quantify. You will have to take into consideration things such as inflation, interest rates, and more.
These factors are difficult to account for and can easily be missed thus leading to a conclusion of CBA that provides inaccurate data and analysis.
Even when you consider CBA for smaller projects and decisions there are still some disadvantages.
CBA involves quantifying costs and benefits that may otherwise not be quantitative in nature which can lead to difficulties and errors.
You also want to ensure you avoid using a CBA as a project budget. CBA provides estimations and should not be confused by stakeholders or management as the actual cost of a project.
How nTask Can Help Your Cost Benefit Analysis?
CBA can provide a great deal of insight and help to many different professionals especially project managers.
One way to help with such an analysis is with the use of nTask.
nTask is a project management tool that offers a variety of features to smooth out the project management lifecycle and help you manage all those varying elements.
In the case of a CBA, nTask can provide valuable modules to aid in the analysis of your upcoming project or help to make a difficult decision.
nTask’s risk management module offers the option to highlight any potential risks that are associated with a project, create mitigation strategies, as well as highlight these risks graphically on a risk matrix.
You can also use the task management tools and Gantt charts to help plan the project and view what the project schedule will look like which can aid in identifying costs and payback time.
For a full description of nTask’s available tools and features check out the website here.
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1. How do you do a Cost-benefit analysis of IT project
As suggested in the post
1. Create a list of potential costs and benefits.
2. Put a financial value on all of the costs and benefits identified.
3. Compare the costs and benefits.
2. What is a cost-benefit analysis in Project Management?
Cost-benefit analysis compares the expected or estimated costs and benefits (or opportunities) connected with a project choice to evaluate if it makes business sense.