Previously, you learned that a cost-benefit analysis is the process of adding up the expected value of a project — the benefits — and comparing them to the dollar costs. This reading will discuss the benefits of conducting a cost-benefit analysis, guiding questions to help you and your stakeholders run one, and how to calculate return on investment (ROI).
The benefits of a cost-benefit analysis
A cost-benefit analysis can minimize risks and maximize gains for projects and organizations. It can help you communicate clearly with stakeholders and executives and keep your project on track. Because this type of analysis uses objective data, it can help reduce biases and keep stakeholders' self-interest from influencing decisions.
Comparing a project’s benefits to costs can help you make a strong business case to stakeholders and leadership and ensure your organization pursues the most profitable or valuable projects. Organizations use cost-benefit analysis to reduce waste and invest their resources responsibly.
Guiding questions for a cost-benefit analysis
When you’re pursuing a project, the benefits should outweigh the costs. You and your stakeholders must consider questions like the ones that follow early on while you prepare the proposal.
To determine the benefits of a project, you might ask:
- What value will this project create?
- How much money could this project save our organization?
- How much money will it bring in from existing customers?
- How much time will it hold?
- How will it improve the customer experience?
To determine the costs of a project, consider questions such as:
- How much time will people have to spend on this project?
- What are the one-time costs?
- Are there any ongoing costs?
- What about long-term expenses?
You might also consider questions about intangible benefits. These are gains that are not quantifiable, such as:
- Customer satisfaction. Will the project increase customer retention, causing them to spend more on the company’s products or services?
- Employee satisfaction. Is the project likely to improve employee morale and reduce turnover?
- Employee productivity. Will the project reduce employee’s overtime hours, saving the company money?
- Brand perception. Is the project likely to improve the company’s brand perception and recognition, attracting customers or providing a competitive advantage?
You can also flip these questions to consider intangible costs. These are costs that are not quantifiable. For example, might the project put customer retention, employee satisfaction, or brand perception at risk?
When assigning values to tangible or intangible costs and benefits, you can reference similar past projects, conduct industry research, or consult with experts.
Calculating costs and benefits
Calculating costs and benefits is also called calculating return on investment, or ROI. There are many ways to determine a project’s ROI, but the easiest way is to compare the upfront and ongoing costs to its benefits over time.
One familiar ROI formula is:
In this formula, G represents the financial gains you expect from the project, and C represents the upfront and ongoing costs of your investment in the project.
For example, imagine your project costs $6,000 upfront plus $25 monthly for 12 months. Twenty-five dollars for 12 months equals $300 per year, meaning your total cost is $6,300. You estimate the project will bring in $10,000 in revenue over that year. That leaves you with:
- G = $10,000
- C = $6,300
Now, using the formula above, you plug in the amounts as follows:
- ($10,000 — $6,300) ÷ $6,300 = ROI
Then you proceed with the calculation:
- First, inside the parentheses: 10,000–6,300 = $3,700
- Next, $3,700 ÷ $6,300 = 0.5873
- Finally, 0.5873 = 58.7%
The ROI comes to 0.587, or 58.7%. Consider this a strong ROI, so you decide to pursue the project.
Key takeaway
Performing a cost-benefit analysis can help you and your stakeholders determine if taking on a new project makes sense by evaluating if its benefits outweigh its costs. You can reference the guiding questions and ROI formula in this reading when conducting cost-benefit investigations for your prospective projects.
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