When managing a project, one is required to make a lot of key decisions. Project managers strive to control costs while getting the highest return on investment and other benefits for their business or organization. A cost-benefit analysis (CBA) is just what they need to help them do that.
In a project, there is always something that needs executing, and every task has a cost and expected benefits. Because of the high stakes, good project managers don’t just make decisions based on gut instinct. They prefer to minimize risk to the best of their ability and act only when there is more certainty than uncertainty.
But how can you accomplish that in a world with myriad variables and constantly shifting economics? The answer: consult hard data collected with project management software, reporting tools, charts and spreadsheets. You can then use that data to evaluate your decisions with a process called cost-benefit analysis (CBA). Intelligent use of cost-benefit analysis will help you make cost-effective decisions and maximize gains both for your project and your organization.
Before we explain how to do a cost-benefit analysis, let’s briefly define what it is.
What Is a Cost-Benefit Analysis?
A cost-benefit analysis (CBA) is a process that is used to estimate the costs and benefits of decisions in order to find the most cost-effective alternative. A CBA is a versatile method that is often used for the business, project and public policy decisions. An effective CBA evaluates the following costs and benefits:
- Direct costs
- Indirect costs
- Intangible costs
- Opportunity costs
- Costs of potential risks
- Total benefits
- Net benefits
We’ll expand on these costs and benefits on our cost-benefit analysis example below.
Keeping track of all these figures is made easier with project management software. For example, ProjectManager has a sheet view, which is exactly like a Gantt but without a visual timeline. You can switch back and forth from the Gantt to the sheet view when you want to just look at your costs in a spreadsheet. You can add as many columns as you like and filter the sheet to capture only the relevant data. Keeping track of your costs and benefits is what brings in a successful project. Use our tool to get the control you need by taking this free trial.
Cost-Benefit Analysis in Project Management
In project management, a cost-benefit analysis is used to evaluate the cost versus the benefits in your project proposal and business case. It begins with a list, as so many processes do.
There’s a list of every project expense and what the expected benefits will be after successfully executing the project. From that, you can calculate the cost-benefit ratio (CBR), return on investment (ROI), internal rate of return (IRR), net present value (NPV) and the payback period (PBP).
Whether the benefits outweigh the costs or not will determine if action is warranted or not. In most cases, if the cost is 50 percent of the benefits and the payback period is not more than a year, then the action is worth taking.
The Purpose of Cost-Benefit Analysis
The purpose of cost-benefit analysis in project management is to have a systemic approach to figure out the pluses and minuses of various paths through a project, including transactions, tasks, business requirements and investments. The cost-benefit analysis gives you options, and it offers the best approach to achieve your goal while saving on investment.
There are two main purposes in using CBA:
- To determine if the project business case is sound, justifiable and feasible by figuring out if its benefits outweigh costs.
- To offer a baseline for comparing projects by determining which project’s benefits are greater than its costs.
How to Do a Cost-Benefit Analysis
According to the Economist, CBA has been around for a long time. In 1772, Benjamin Franklin wrote of its use. But the concept of CBA as we know it dates to Jules Dupuit, a French engineer, who outlined the process in an article in 1848.
Since then, the CBA process has greatly evolved. Let’s go through this checklist to learn how to do a cost-benefit analysis:
1. What Are the Goals and Objectives of the Project?
Create a business case for your project and state its goals and objectives.
2. What Are the Alternatives?
Before you can know if the project is right, you need to compare it to similar past projects to see which is the best path forward. You can quickly check their success metrics such as their return on investment, internal rate of return, payback period and benefit-cost ratio.
3. Who Are the Stakeholders?
List all stakeholders in the project. They’re the ones affected by the costs and benefits. Describe which of them are decision-makers.
4. How Will You Measure Costs and Benefits?
You need to decide on the metrics you’ll use to measure all costs and benefits. Some of them will have a dollar value, while others will need other metrics. Also, how will you be reporting on those metrics?
The process can be greatly improved with project management software. ProjectManager has one-click reporting that lets you can create eight different project reports. Get data on project status, variance and more. Reports can be easily shared as PDFs or printed out for stakeholders. Filter any report to display only that data you need at the time.
5. What Is the Outcome of Costs and Benefits?
Look over what the costs and benefits of the project are, assign them a monetary value and map them over a relevant time period. It’s important to understand that CBA estimates the monetary value of present and future costs and benefits.
6. What Is the Common Currency?
As mentioned on the last step, you can’t compare the current monetary value of costs and benefits with future rates. That’s why you’ll have to calculate the time value of money, discount rate, and net present value of cash flows.
However, in some cases, the benefits of a project are not measurable in monetary value. If you find yourself in that position, you should do a cost-effectiveness analysis.
7. What Is the Discount Rate?
The discount rate is used to calculate the present value of the future cash flows coming in or out of your project.
8. What Is the Net Present Value of the Project?
The net present value of a project is a measurement of profit that is calculated by subtracting the present values of cash outflows from the present values of cash inflows over a period of time.
9. What Is the Sensitivity Analysis?
A sensitivity analysis is a probability method used in management and business to determine how uncertainty affects your decisions, costs and profits.
In a project management CBA, sensitivity analysis is used to determine the benefit-cost ratio of probable scenarios. You can use Excel or more specialized software to do sensitivity analyses.
10. What Do You Do Once Your CBA Is Complete?
The final step after collecting all this data is to make the choice that is recommended by the CBA, which is the one with the highest benefit-cost ratio.
Cost-Benefit Analysis Example
Now let’s put that theory into practice. For our cost-benefit analysis example, we’ll do an assessment of a project that involves delivering a product as its main goal.
- Direct costs: These are all the costs that are directly related to the manufacturing of the product. Such as materials, equipment, labor, etc.
- Indirect costs: Other expenses that are not directly related to the product such as rent, utilities, or transportation costs.
- Intangible costs: Any other costs that are can’t be quantified, such as the brand damage if the market doesn’t respond positively to the product.
- Opportunity costs: The loss of opportunities that occurs when a decision is made instead of another. For example, you could have chosen to manufacture a product that could have been more profitable than the one you chose to make.
- Costs of potential risks: Any project is susceptible to a variety of risks. You should always consider that you might have unexpected costs at some point.
- Direct Benefits: The measurable benefits in monetary value that you get from the project. In this case, the revenue, sales and profit obtained from your product.
- Indirect Benefits: Benefits that you can perceive but not necessarily measure such as increased brand awareness.
Now that you have the costs and benefits of your project, it’s time to assign a monetary value to them. In this case we can only do that with our direct and indirect costs and our direct benefits. However, you should assign other metrics like key performance indicators to those that can’t be measured with a dollar amount.
Once you estimate the dollar value of your costs and benefits using past-project data, you’ll have to compare them to see if the costs outweigh the benefits.
However, to do a more reliable CBA, you’ll need a sensitivity analysis to evaluate different scenarios and how those affect your cost-benefit ratio. For example, try different demand levels on your linear programming equation.
It’s important that you keep in mind that depending on the timeframe of your project, you might have cash flows coming in and out at different times. For this reason, you’ll need to consider the time value of money, discount rate, net present value when comparing cost-benefit cash flows.
Capture all the costs and benefits with project management software. But unlike many apps with inferior to-do lists, ProjectManager has a list view that is dynamic. It adds priority, customized tags and you can assign team members to own each item. Our cloud-based tool will also automatically track in real time the percentage complete for each item. All the data you collect in our list view is also visible throughout the tool. Use whatever view you want, they’re all updated live and ready for you to work with.
How Accurate is Cost-Benefit Analysis?
How accurate is CBA? The short answer is it’s as accurate as the data you put into the process. The more accurate your estimates, the more accurate your results.
Some inaccuracies are caused by the following:
- Relying too heavily on data collected from past projects, especially when those projects differ in function, size, etc., to the one you’re working on
- Using subjective impressions when you’re making your assessment
- The improper use of heuristics (problem-solving employing a practical method that is not guaranteed) to get the cost of intangibles
- Confirmation bias or only using data that backs up what you want to find
Are There Limitations to Cost-Benefit Analysis?
Cost-benefit analysis is best suited to smaller to mid-sized projects that don’t take too long to complete. In these cases, the analysis can help decision-makers optimize the benefit-cost ratio of their projects.
However, large projects that go on for a long time can be problematic in terms of CBA. There are outside factors, such as inflation, interest rates, etc., that impact the accuracy of the analysis. In those cases, calculating the net present value, time value of money, discount rates and other metrics can be complicated for most project managers.
There are other methods that complement CBA in assessing larger projects, such as NPV and IRR. Overall, though, the use of CBA is a crucial step in determining if any project is worth pursuing.
Templates to Help With Your Cost-Benefit Analysis
As you work to calculate the cost-benefit analysis of your project, you can get help from some of the free project management templates we offer on our site. We have dozens of free templates that assist every phase of the project life cycle. For cost-benefit analysis, use there three.
One of the steps when executing a cost-benefit analysis (as detailed above) includes identifying the stakeholders in your project. You need to list those stakeholders, but our free RACI matrix template takes that one step further by outlining who needs to know what. RACI is an acronym for responsible, accountable, consulted and informed. By filling out this template, you’ll organize your team and stakeholders and keep everyone on the same page.
You can’t do a cost-benefit analysis without outlining all your expenses first. That’s where our free project budget template comes in. It helps you capture all the expenses related to your project from labor costs, consultant fees, the price of raw materials, software licenses and travel. There’s even space to capture other line items, such as telephone charges, rental space, equipment for the office, admin and even insurance. A thorough budget makes for a more accurate cost analysis.
You have your stakeholders identified and your budget outlined, but there’s always the unknown to contend with. You can’t just leave that up to chance: you must manage risk, which is why our free project risk register is so essential. Use it to outline the risks inherent in the project. There are places to list the description of the risk, its impact, the level of risk and who is responsible for it. By maintaining a good risk register you can control the variables in your project and make a better cost-benefit analysis.
Make Any Project Profitable with ProjectManager
No matter how great your return on investment might be on paper, a lot of that value can evaporate with poor execution of your project. ProjectManager is an award-winning project management software that has the tools you need to realize the potential of your project. First, you need an airtight plan.
Our online Gantt charts have features to plan your projects and organize your tasks, so they lead to a successful final deliverable. If things change, and they will, the Gantt is easy to edit, so you can pivot quickly.
Another snag that can waylay a project is your resources. ProjectManager has resource management tools that track your materials, supplies and your most valuable resource: the project team. If they’re overworked, morale erodes and production suffers.
The workload page on ProjectManager is color-coded to show who is working on what and gives you the tools to reassign to keep the workload balanced and the team productive.
Real-Time Cost Tracking
The surest way to kill any project is for it to bleed money. ProjectManager lets you set a budget for your project from the start. This figure is then reflected in reports and in the charts and graphs of the real-time dashboard, so you’re always aware of how costs are impacting your project. ProjectManager has the features you need to lead your project to profitability.
Cost benefits analysis is a data-driven process and requires project management software robust enough to digest and distribute the information. ProjectManager is a cloud-based project management software with tools, such as a real-time dashboard, that can collect, filter and share your results in easy-to-understand graphs and charts. Try it today with this free 30-day trial.
(This post was updated October 15, 2020)