How to do a Cost Benefit Analysis: A 3-Minute Crash Course
Why is cost analysis important?
Here are a few factors supporting the significance of cost analysis for businesses:
Helps decision-making
Due to the ability to compare project results to project costs, cost analysis enables professionals to make decisions about upcoming projects. Professionals can make the necessary changes to the project to increase the earnings or decrease the cost if the cost exceeds the anticipated earnings.
Keeps stakeholders involved
Cost analysis makes sure that businesses involve all relevant parties in the decision-making process. Because they contribute to a company and show interest in projects, stakeholders are an essential component of business operations, so it’s crucial that companies involve stakeholders in project data. By distributing cost analysis data, stakeholders can get the knowledge they need to make wise financial and budgetary decisions.
Solves problems
Cost analysis can help identify financial problems and find solutions. Cost analysis can help a business stay organized, gain a better understanding of its finances, and plan for future projects if it is having trouble managing projects. You can determine which factors have an impact on a project’s profitability by conducting routine cost analysis reviews and addressing those factors directly.
What is cost analysis?
Calculating the potential profits from a situation or project, then deducting the total costs related to finishing that situation or project, is the process of cost analysis, also known as cost-benefit analysis. It provides an estimate of the project’s profit and contrasts the project’s cost with its anticipated financial benefits. Cost analysis is a common tool used by finance professionals to show clients their potential profits from a project.
How to calculate cost analysis
To assist you in determining a cost analysis ratio, use the following steps:
1. Determine the reason you need a cost analysis
Depending on why you need a cost analysis done, the way you use a cost analysis can change. Find out why a cost analysis is necessary so that you can better understand the variables you can use. For instance, if you are conducting a cost analysis to develop a project budget, you may use earlier financial data pertaining to budgets.
2. Evaluate cost
The following step is to assess all of the project’s expenses. To have a list of all the costs available for use in subsequent steps, it might be helpful to write them all down. Make sure to account for any unforeseen project expenses as well as potential future cost increases. Here are the factors to consider when evaluating cost:
3. Compare to previous projects
Compare your current cost analysis project to earlier projects as the next step. You can use this data to find comparable expenses and calculations to include in your analysis. You can make sure that you have enough data to create a realistic understanding of your costs and income by comparing your data to other cost analysis projects.
4. Define all stakeholders
It’s crucial to identify the project’s stakeholders in order to produce an accurate cost analysis. Stakeholders are people or organizations with an interest in the project. They might contribute time or money to the project’s development. Stakeholder information must be included in cost analysis because stakeholders are affected by a project’s profitability.
5. List the potential benefits
The potential benefits of a project, or how much money they could potentially bring in, are then listed. Benefits can vary depending on the project type being studied, but to get an accurate estimate of benefits, be sure to speak with stakeholders and financial analysts about how to value the project benefits.
6. Subtract the cost from the outcome
The next step is to calculate your cost analysis ratio by deducting all costs from the anticipated benefits of your project. For instance, $2,500-$1,000=$1,500 if a project’s total costs are $1,000 and its benefits are $2,500. You can generate several cost analysis ratios if you have several different scenarios for how much profit a project might bring in.
7. Interpret your results
It’s crucial to interpret the findings of your cost analysis once you have the value so that you can decide whether to move forward with the project. In general, it is a good idea to continue with the project if your results meet the objective of the income you hope to earn from it. Consider reducing the project’s cost or finding ways to increase the benefits if the cost analysis indicates that you won’t be able to achieve your goal.
Example of cost analysis
Here is an example of cost analysis for a project:
By the spring of next year, a clothing company wants to decide whether or not to introduce a new line of clothing. They decide that a cost analysis would provide them with information about how much money they would make from the project, allowing them to decide whether or not to pursue the clothing line. They have determined that their objective with the spring clothing line is to generate more than $1,000.
Their accountant takes a seat and totals up all expenses for the new clothing line. They calculate that their direct costs would be $500, indirect costs would be $400, real costs would be $600, tangible costs would be $200, and intangible costs would be $500.
Next, they use data from earlier clothing lines to compare financial aspects. They learn that the costs for their winter clothing line from two years ago are comparable, so they can assess how much they earned from the sale of that line of clothing. When they examine the prior sale, they discover that they made a significant profit.
The next step for them is to identify all the participants in their upcoming spring clothing line. They recognize five different stakeholders, and they are aware that the stakeholders should be informed about the cost analysis. Additionally, they seek input from the stakeholders on how to maximize benefits while minimizing costs.
Then, they enlist a financial analyst’s assistance to compile a list of the potential advantages of the clothing line. They discover that they can make $4,000 overall if they sell all of their stock.
In order to complete their cost analysis, they add up all of their expenses: $500 + $400 + 600 + 200 + 500 = $2,200. The total costs are then subtracted from the benefits, which comes to $4,000 – $2,200 = $1,800.
The clothing company decides to move forward with the project because the cost analysis revealed that they can make more money than their initial goal of $1,000 with the clothing line.
