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The Concept of Cost-Benefit Analysis

By - - [ Must Read Economy ]

Cost-benefit analysis (CBA) also known as Benefit-cost analysis (BCA) is an economic tool that is used to systematically decide whether to carry out a specific project or not. CBA is a simple technique that is quick and easy to use for financial decision making before carrying out a project.

The concept of CBA was introduced in the 1840s by a French engineer and economist known as Jules Dupuit. It became a significant tool in the 1950s as a way of comparing the cost of a project and its benefits.

As the name implies, cost-benefit analysis is a method that involves the summation of the benefits of a particular project compared to its corresponding costs. This means that CBA enables you to know the exact cost you will spend on a project and how much the project will benefit you.

The CBA technique can be used in various situations like:

  • Carrying out a new initiative or project
  • To determine if a capital project is feasible
  • The possibility of hiring a new team

Note that the technique is best in simple and quick financial decisions making.

Steps on how to use the CBA tool

Below are the steps to follow when using the cost-benefit analysis tool

  1. Deliberate on the costs and benefits

The first thing to do is to deliberate on all the costs of carrying out the project. List them out accordingly. Do the same for the benefits of the project. Think if there are other costs that might likely occur unexpectedly. Deliberate on any anticipated benefits that may occur.

If you are able to come up with such costs and benefits, think of how long (the lifespan) the project will take and what the benefits and costs might be overtime.

  1. Assign financial value to the costs

The costs of a project are relatively easy to calculate. The costs includes money spent on human efforts, cost spent on needed physical resources e.t.c.

It is important for you to be able to think of incurred costs once the project is executed. A good example of such cost is the cost of additional staff.

  1. Assign financial value to the benefits

This step is more complex compared to step two above. This is because it is very difficult to accurately forecast revenue. Also, aside from the expected benefits you are anticipating, there are sometimes other soft benefits generated from the project which are also very important. For example, it will be difficult to measure the impact of a project on the environment.

  1. Compare the costs and benefits

This is the last step to take. Haven known the value of all the project costs and benefits, is left for you to compare them. You do this by taking the difference of all the sum total of cost and the sum total of benefits. This can help you to know if the benefits are more than the costs. Also observe the point at which your benefit will be able to pay for the cost, it is usually refer to as the breakeven point. The payback time is the period it will take you to reach the breakeven point.

Use your analysis to determine if you are going to carry out the project or not.

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