All about Cost-Benefit Analysis that One Should Know in the Context of Project Management
All kinds of organizations whether they have been created to gain profit or not, need to take up new initiatives like developing new policies and bringing about new changes to improve their present business state in a way that provides new benefits for their organization and stakeholders. These new initiatives are taken up as new projects by the organizations.
The purpose of the projects is mainly, to create a business or social value. Every new project requires fresh investments of money and efforts. Organizations need to make decisions that care by giving them a lot of thought, so that they provide a clear justification for the investments that they would need from stakeholders. This is known as Cost-Benefit Analysis in Project Management.
What is Cost-Benefit Analysis or CBA?
Taking new initiatives has always been important for the evolution of mankind at all stages of life whether it be personal, social, or business-related. On a business level, these initiatives can be developing new products, new services, or new capabilities for better production. As a result, there has always been a need to make sound and efficient decisions. Cost-Benefit Analysis is the most fundamental method that is used by organizations all over the world to compare the financial cost that is required to successfully launch new initiatives of an organization and reap the benefits that would be received from such projects.
The responsibility of leaders on financial matters continues to rise day by day; they have to take new initiatives all the time for the welfare of their company and because of that Cost-Benefit Analysis has become an integral part of project management. Cost-Benefit Analysis has been a very important part of policy matters in government-related projects ever since 1936 when engineers used Cost-Benefit Analysis for Federal Waterway Infrastructure projects.
The most basic approach to performing a Cost-Benefit Analysis would be estimating all the costs that are required for a project and carefully evaluating and predicting the benefits that the organization would receive from it to the most approximate amount. The benefits can be quantifiable or non-quantifiable such as improvement in life quality, ease of living or doing business, and many more.
The Goal of Cost-Benefit Analysis
Every new project requires investments by investors (such as stakeholders) so the organization is supposed to make them believe that the investments would be profitable and would not go to waste. This can only be done by a Cost-Benefit Analysis. The two most important goals or purposes of conducting a Cost-Benefit Analysis are:
- Determining if an investment decision is sound or not and whether the benefits received out of it are more in comparison to its costs. Cost-Benefit Analysis also helps to find out the difference between these benefits and initial costs or investments that were put into a project.
- Provides a basis so that alternate investment options can be compared to find the one that provides the most benefits. The total expected cost of each investment option is compared with its total expected benefits thereby a basis gets created which can help to choose the most preferable option.
All about Costs and Benefits that You Need to Know
The first and foremost part of Cost-Benefit Analysis is estimating all the costs that would be incurred in undertaking a new project. This is done by carefully estimating and listing down, for instance, the required quantity, quality, and duration of material, labor, equipment, and facilities that would be needed to complete the project. Furthermore, the estimation of the cost of contingency, inflation, financing (if required), and other services (training, liaison, etc.) is also required to complete the activities of the project. Cost estimation can be accurate if all the activities of the project can be identified and the resource quantities can be estimated.
The second most important part of Cost-Benefit Analysis is estimating all benefits. Every investment is done because it is expected to yield benefits in the future. Benefits can be financial such as an increase in profit margins and working efficiency or they can be non-financial such as an increase in comfort, ease of working, the morale of employees, satisfaction levels, peace, social benefits, and much more. Financial benefits are quantifiable so they can be easily and accurately estimated whereas quantifying and estimating non-financial benefits can be a challenging task.
Comparing Costs and Benefits
This step is very important after both the costs and benefits have been estimated. By comparing them we can know whether the benefits outweigh the investment costs or not. If they do, then the proposals would be taken up for further detailed consideration by the organizations. Organizations may also provide guidelines related to the minimum expected difference between benefits and costs for the project at hand.
Furthermore, after the Cost-Benefit Analysis has been done, organizations may also lay down guidelines regarding social benefits (that are mostly non-financial) to provide a clear decision making for comparing the pros and cons of different sorts of investments.
Challenges and Considerations that Need to be Taken Care of while Performing a Cost-Benefit Analysis
- The Accuracy of Cost-Benefit analysis
For an accurate prediction, it is required that Cost-Benefit Analysis is done by technical and financial experts.
- The Limitations of Cost-Benefit Analysis
Cost-Benefit Analysis requires solid maturity when it comes to knowledge and the availability of past data, to provide an accurate estimation and comparison between the cost and benefits of projects.
- The Risks and Uncertainties in Cost-Benefit Analysis
It is important to understand the risks and uncertainties while doing a project. Once the project is complete, it is important to understand the uncertainties involved in realizing benefits.
Cost-Benefit Analysis is one of the most important methods in project management for finding out the estimation of doing a project (costs or investments required) and the benefits that would come out of those investments. It also provides a comparison between the estimated costs and benefits. Organizations compare various investments and choose the most profitable one for their company.