What Is a Cost-Benefit Analysis? And How to Conduct One

When facing a critical business decision, it's important to understand the different outcomes. A cost-benefit analysis—sometimes called a cost analysis—is an important business analytics tool used to make more informed, data-driven decisions. A cost-benefit analysis (CBA) comes in handy across business needs, including when you're evaluating the feasibility of a proposed project or contemplating a shift in sales strategy.  

In this article, we'll discuss more about cost-benefit analyses, why they're important, and how to do one. Afterward, if you're interested in learning more about business analytics, consider enrolling in the University of Illinois' Business Analytics Specialization, where you'll gain a well-rounded knowledge of business analytics that integrates the areas of data science, analytics, and business decision-making.

What is a cost analysis?

A cost analysis—or a cost-benefit analysis (CBA)—is a way to evaluate business decisions and better understand any associated benefits and risks. Essentially, a CBA quantitatively compares the estimated costs and benefits, providing a numerical indicator that helps you assess whether a proposed decision is economically sound. 

For instance, consider a scenario where a company wants to launch a new product line. Performing a CBA would help you discern the preliminary expenditure, potential revenue, and the overall financial viability of this endeavor. Based on this information, you can determine the total benefits minus the total costs, which can help stakeholders make informed financial decisions.

What are the direct outcomes of conducting a cost analysis?

If you conduct a cost analysis, strategic budgeting is one of the direct outcomes. Stakeholders, including investors, need relevant data for budgeting decisions. When you provide transparent cost analysis, you foster collaboration, ensuring stakeholders contribute meaningfully to budgeting. 

Why is a cost analysis important?

Cost-benefit analyses can take a significant amount of time to complete and require a substantial amount of data to provide an accurate picture. However, if you work in business analytics, business intelligence, or finance (as just a few examples), conducting a cost-benefit analysis can be valuable.  

CBA benefits:

• Present fact-based data or evidence to support new project ideas.

• Identify and track not-so-obvious or hidden costs, such as intangible costs.

• Mitigate the impact of subjective biases like personal opinion or judgment that may inadvertently influence decision-making.

Cost analysis vs. return on investment

Return on investment (ROI) helps measure tangible gains against the costs of implementing your proposed project or solution. In contrast, cost-benefit analysis (CBA), which is more complex, aids in measuring both tangible and intangible costs and benefits. Since ROI is slightly more simplistic, you can show it to executives as evidence that your proposal is sound. Typically, an ROI needs to be greater than zero for executives and investors to support your project.

ROI = (net benefits/total cost)*100

Net benefits = total benefits - total costs

How to perform a cost-benefit analysis

A universally agreed-upon method for conducting a cost-benefit analysis doesn’t exist; however, most techniques have the following steps in common:

1. Define project goals and scope.

Setting objectives can help enhance the accuracy of your cost-benefit analysis. For example, you might want to conduct a CBA to assess the cost and benefits of adopting a remote work policy within your organization.  

After outlining your project scope, choose a metric for comparing the associated benefits and costs. You can choose to use job hours, actual currency, or customer satisfaction index as a metric, depending on the nature of your project. If you use a specific currency as a metric, ensure that costs and benefits are expressed in the same currency for an accurate comparison. 

2. Record estimated costs and benefits.

Create two lists to document your project's estimated costs and benefits.

Costs can be:

• Direct: Labor, inventory, raw materials, and manufacturing expenses)

• Indirect: Utilities and rent

• Opportunity: Missing a chance to do something cheaper, an example being hiring additional employees when you don't need them

• Intangible: Advertising expenses, branding costs, market research, and legal fees

While benefits can be:

• Direct: Increased revenue from a new product line

• Indirect: Strengthened customer loyalty and positive word-of-mouth

• Competitive: Establishing market leadership by introducing unique features or services

• Intangible: Elevated company reputation, stronger brand image, and improved employee morale 

3. Set a value for every cost and benefit.

After compiling all costs and benefits, assign a value, such as a dollar amount, to each for comparison. Note that quantifying intangible and indirect costs/benefits may not be straightforward. Nevertheless, you can utilize analytical tools to determine probable values.

4. Compare total costs with total benefits.

You can sum the costs and then deduct that result from the total benefits. If total benefits exceed total costs, proceed with your business goals. If total costs surpass total benefits, you may want to reevaluate your set targets to prevent a loss if you move forward with the project. 

Example: A small café is contemplating introducing a new specialty coffee blend to attract more customers. Emily, the café owner, conducted a cost analysis to determine its feasibility. 

The direct cost for the new blend is $300, which includes coffee beans and packaging materials. Indirect costs, covering utilities and additional staff, amount to $150. Intangible costs, like potential disruptions and research, are capped at $50. 

The total costs sum up to:

• $300 (direct) + $150 (indirect) + $50 (intangible) = $500.

As a next step, Emily enlists a financial analyst to gauge probable benefits. If the new blend sells well, the analyst forecasts an additional $700 in revenue for the café. 

Finally, to complete the cost-benefit analysis, the financial analyst subtracts the onset cost from the expected revenue:

• $700 (benefit) - $500 (cost) = $200

The analysis reveals a potential profit of $200, coupled with the competitive advantage of offering a unique specialty coffee blend. Encouraged by the positive outcome, Emily proceeds to make the required investment. 

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4 examples of a cost analysis

The gains resulting from a cost-benefit analysis extend beyond launching a new product, service, or policy because you can also use it for employee training and expanding your business. The following scenarios demonstrate the analysis’ versatility in guiding your decisions across different aspects of a business:

1. Implementing employee training programs

Scenario: Investing in digital training platforms for staff development

Rationale for CBA: Evaluating the costs of training against anticipated improvements in employee skills, productivity, and organizational performance

2.  Adopting sustainability 

Scenario: Incorporating eco-friendly packaging to limit carbon footprint

Rationale for CBA: Assessing the costs of adopting sustainable practices against long-term benefits such as improved brand image and potential cost savings

3. Introducing customer loyalty programs

Scenario: Establishing a customer loyalty program to enhance customer retention

Rationale for CBA: Determining the costs of the program against projected gains in customer loyalty, repeat business, and overall customer satisfaction

4. Expanding geographic presence

Scenario: Considering expansion into a new city or country

Rationale for CBA: Analyzing expansion costs versus potential market growth and profitability 

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