Cost-benefit analysis

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Development of Cost-Benefit Analysis and Revenue Studies for Entrepreneurial Ventures, Option Assessment

Development of Cost-Benefit Analysis and Revenue Studies for Entrepreneurial Ventures, Option Assessment

Cost-Benefit Analysis (CBA)

Cost-Benefit Analysis (CBA) is a method used both in the public and private sector as the basis for deciding whether to accept or reject an investment option. Similar to a business plan and an investment study, it analyzes all key elements of a project. The difference between cost-benefit analysis, a business plan, and an investment study lies in the fact that CBA takes into account both financial and non-financial impacts of a project. Thus, the conclusions include those positive and negative intangible but significant effects that will be the result of taking some action. Cost-benefit analysis also includes sensitivity analysis, which interprets what the outcomes will be if the parameters on which our assumptions are based change.

This tool is very convenient when you have multiple business options at your disposal. For example, if you need to decide whether to build real estate or buy it, cost-benefit analysis can help you compare these two options and make the right decision based on the data you obtain.

What is a Cost-Benefit Analysis?

A Cost-Benefit Analysis, is a method for evaluating a project, investment, or business decision that takes into account all related costs and benefits. The goal of such an analysis is to quantify all financial and non-financial aspects of a business venture to assess its value.

For public institutions, it is a mandatory element within the feasibility study when applying for funding its large projects. Entrepreneurs rarely use this tool to evaluate their decisions, but for large projects, cost-benefit analysis is the best foundation for making business decisions.

Methodology of Cost-Benefit Analysis

In the approach to cost-benefit analysis, the first step is to identify all the costs and revenues associated with the project. Financial costs and benefits are easy to estimate, but it's important to consider and evaluate non-financial ones as well.

Some non-financial costs and benefits that may arise include, for example, extended delivery times, improved employee or user satisfaction, and other intangible effects. Quantifying such impacts can be difficult and often requires additional engagement from experts in specific fields or assessing results through surveys of users or employees.

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Result of Cost-Benefit Analysis

A Cost-Benefit Analysis quantifies all the positive and negative effects related to a decision or action. The difference between them is the result of the cost-benefit analysis and the basis for business decision-making.

Cost-benefit analysis covers all measurable costs and benefits related to a business venture, such as revenue generated and cost savings.

Additionally, it includes benefits and costs that are not measurable but can be quantified using a specific methodology. These might include employee and user satisfaction, product or service quality improvement, opportunity costs, and all other effects of a business decision.

Cost-benefit analysis includes scenarios in which we can see the results of a business decision under different assumptions. Complex cost-benefit analyses compare the results of several projects simultaneously.

This is done by quantifying all the future effects of a business decision and discounting them to present value. This provides data that can be compared and used for informed business decision-making.

Based on the analysis, recommendations for the project are made, determining the project's value, which, in comparison with cost-benefit analyses of other business options, helps make the right business decision.

Timeframe of Cost-Benefit Analysis

When conducting a cost-benefit analysis, it's crucial to determine the time period within which the project will be evaluated. Moreover, it's important to establish whether costs and benefits are one-time or recurring within the observed timeframe.

The timeframe is essential because it defines the value of money. The longer the timeframe, the more sensitive the analysis result will be to changes due to unforeseen market conditions. Therefore, cost-benefit analysis includes a sensitivity analysis, which assesses potential risks resulting from changes in the assumptions on which the project is based.

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Advantages and Disadvantages of Cost-Benefit Analysis

Like all other project evaluation methods, cost-benefit analysis has its advantages and limitations:

Advantages:

The most important advantage is that cost-benefit analysis enables decision-making based on quantified data.

Cost-benefit analysis thoroughly examines all costs and benefits of a business decision, providing a comprehensive insight into the effects of a business venture.

It is extremely useful when considering large projects carried out by public administration bodies, as assessing only the financial impacts of such projects would not provide a realistic evaluation.

Non-financial effects are difficult to quantify, and their quantification can be based on subjective assessments.

Disadvantages:

Not cost-effective for evaluating small projects due to complexity.

When Is It Useful to Prepare a Cost-Benefit Analysis?

Cost-Benefit Analysis is a quantified result of a business decision and can be used in any case when analyzing whether to take action.

In practice, due to its complexity, it is used for larger projects, such as:

Implementing a new business strategy

Deciding on the purchase of fixed assets

Deciding to introduce new business processes

Measuring the effects of new business policies on operations

Determining the impact of changes in the organizational structure or business processes on operations.