Cost-Benefit Analysis

Cost-benefit analysis (CBA) is the weighing-scale approach to decision-making. All the plusses (cash-flows and other intangible benefits) are put on one side of the balance and all the minuses (the costs and disadvantages) are put on the other.  Whichever weighs the heavier wins.

Example of a CBA:

A company that would like to buy new software to improve its business might conduct a CBA to decide and make up its mind.

On the minus (cost) side would be:

- the price of the software,

- the cost of consultants to install and implement the software, and

- the cost of training for the users of the software.

However on the plus (benefits) side would be:

- improved business processes (leading to an annual cost decrease),

- due to better available information, being able to take better decisions (leading to additional cash-flows), and

- increased staff moral from using the state of the art tools for running the business.

A frequently made mistake in the CBA method is to use non-discounted amounts for calculating the costs and benefits. A method like NPV or Economic Value Added or CFROI is strongly recommended, because all of these account for the time value of money.

A frequent problem with CBA is that typically the cost are tangible, hard and financial, while the benefits are hard and tangible, but also soft and intangible. Caution should be taken here against people who claim that "if you can't measure it does not exist / it has no value". Especially in more strategic investments, frequently the intangible benefits clearly outweigh the financial benefits.

Book: Anthony E. Boardman - Cost-Benefit Analysis: Concepts and Practice (2nd Edition)
Book: Henry M. Levin, Patrick J. McEwan - Cost-Effectiveness Analysis : Methods and Applications

More methods and models

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