COST/BENEFIT ANALYSIS

In order to survive, the main goal of any business is, of course, to make money. To make money, however, requires spending money. Hence, it is important to know if an investment of money in a particular endeavor or product will generate a rate of return and, if so, when. This approach is called the cost/benefit analysis.

A good cost/benefit analysis has several characteristics. It lists all the major costs for the existing and new product, service, and so forth. These include costs for investments, implementation, and operations. It also includes a breakeven analysis, which determines when the costs of the existing product or service are equal to the proposed one.

Cost/benefit analysis contains a payback period, or the time frame in which the proposed product or service accumulates earnings to pay for itself. It has a rate of return that the proposed product or service is to earn after accounting for all costs. It also includes a net present value calculation, which is a discounted cash flow analysis using the present value of money. In other words, it accounts for the devaluation of money over time.

The benefits of a cost/benefit analysis are obvious. One, it helps to identify the value of an existing product, service, and so on. Two, it forces reevaluation of the current mode of doing business. Three, it encourages sound decisions.

for Performing a Cost/Benefit Analysis

• Define the current and proposed product, service, and so on.
• List all major assumptions for the analysis.
• Calculate the investment, implementation, and operating costs.
• Perform a breakeven analysis.
• Calculate the payback period.
• Calculate the rate of return.
• Calculate the net present value.
• Perform the calculations for different scenarios.
• Evaluate the differences among the scenarios.
• List recommendations.
• Select the most appropriate recommendation.