A cost analysis (also called a cost-benefit analysis or CBA) is a detailed profile of potential risks and rewards in planning a business. Several factors are involved, even some abstract considerations, which make the creation of CBA analysis more of an art than a science, even if a view based on numbers is always fundamental. A CBA is useful for making different types of business and personal decisions, especially if they concern the possibility of making a profit (although this is not essential). While conducting a cost-benefit analysis is a complex task, you don't have to have a business degree to learn how. Anyone who is willing to brainstorm, research and analyze data can conduct a high-quality analysis.
Steps
Step 1. Define the cost unit of the ACB
Since the purpose of the CBA is to determine whether a certain project or initiative is worth the expenses necessary to implement it, it is important to establish exactly the measures of CBA in terms of "costs" from the outset. Typically, a CBA measures costs in terms of moneyBut in cases where it's not about money, CBAs can measure costs in terms of time, energy usage, and more.
To explain better, in this article we will create an example of ACB. Suppose you have a lucrative business with a lemonade kiosk on summer weekends and want to conduct a cost analysis to decide whether it is beneficial to expand and have a second kiosk across town. In this case, what we're interested in first is whether this second kiosk would make us more money in the long run or if the expenses associated with the expansion would be prohibitively high
Step 2. Write down the tangible costs of the project in detail
Almost all projects have costs. For example, business ventures require initial cash investments to purchase goods and equipment, staff training, and the like. The first step for a CBA is to make an exhaustive and detailed list of these costs. It will also be useful to consult similar projects to find costs to include in your list that you may not have considered. The costs could be expenses that are made once or that have to be paid over and over again. Costs should be based on current pricing and / or market research whenever possible; when this is not possible, they should be intelligent and thoughtful estimates.
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The types of costs to be included in the CBA are listed below:
- The prices of goods or equipment related to the business
- Shipping, handling and transport costs
- Operating costs
- Employee expenses (wages, training, etc.)
- Real estate (offices for rent, etc.)
- Insurance and taxes
- Utilities (electricity, water, etc.)
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Let's make a detailed list of the costs for the launch of our hypothetical lemonade stand:
- Equipment in terms of lemons, ice and sugar: 20 € / day
- Wages for two people at the kiosk: 40 € / day
- A good blender (for smoothies): one-time expense of 80 €
- A large portable fridge: one-time expense of € 15
- Wood, cardboard and other material for the kiosk and signs: single cost of 20 €
- The income of the kiosk is not taxable, the cost of the water used is negligible, and we have a policy to open kiosks in public places, so we do not have to consider expenses for taxes, utilities or real estate.
Do a Cost Analysis Step 3 Step 3. Detail any “intangible” costs
Costs for projects rarely consist solely of material and real expenses. CBAs usually "also" take into account the demands of intangible things, such as time and energy needed to complete the project. Although these things cannot actually be bought and sold, real costs can be assigned, by establishing how much money a person would hypothetically earn if they used these items for another purpose. For example, even if it costs nothing to technically quit for a year to write a novel, one must consider that by doing so he will be without a salary for a year. In this case, what we do is exchange "money" for "time", buying a year for ourselves for the price of a year's salary.
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Listed below are the types of intangible costs to be included in the CBA:
- The cost of time spent on a project, ie the money that "could" be earned if this time was spent doing something else
- The cost of energy used for a project
- The cost of establishing a certain routine
- The cost of possible losses during the implementation of the planned initiative
- The value of the risk factor of intangible things such as security and trust accorded to the customer.
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Let's consider the intangible costs of opening a new lemonade stand. Let's assume that the current kiosk generates 20 € / hour for 8 hours a day, 2 days a week (Saturday and Sunday):
- Closure of the existing kiosk for one day to be able to build the new one, prepare the signs and find the new location: loss in profits of € 160.
- 2 hours a week for the first two weeks spent solving problems in the supply chain: loss in profits of € 80 during the first two weeks.
Do a Cost Analysis Step 4 Step 4. Make a detailed list of the designed benefits
The purpose of a CBA is to compare the benefits of a project with the costs: if the former clearly outweigh the latter, the project will probably be carried forward. The breakdown of benefits is done the same way the cost part is done, although you will most likely have to rely more on plausible estimates. Instead, try to back up your estimates with evidence from research or similar projects and assign a monetary amount to all tangible or non-tangible ways you will see a positive return from your initiative.
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Listed below are the types of benefits to be included in the CBA:
- Income produced
- Money saved
- Interest accrued
- Equity investments built
- Time and effort saved
- Continuous use by customers
- Intangibles such as recommendations, customer satisfaction, happier employees, safer workplace, etc.
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Let's calculate the expected benefits for our new lemonade stand and provide an explanation for each estimate:
- Thanks to the high foot traffic, a competing kiosk near the hypothetical site of the new kiosk will make a whopping 40 € / hour. As our new kiosk should compete for the same customers and in this area we still don't have recognition among people, we will assume that we will make less than half (15 € / hour or 120 € / day) and that this will potentially grow as it spreads. the item about our lowest prices.
- Most weeks, we will throw away about € 5 of spoiled lemons. We plan to be able to more efficiently divide our equipment between the two kiosks, eliminating this loss. As we are open two days a week (Saturday and Sunday), we will save around € 2,5 / day.
- One of our current employees lives right next to the new kiosk site. By allowing her to work at the new kiosk (by hiring someone else for the old kiosk), we calculate to take advantage of the reduced travel time to keep the kiosk open an extra half hour each day, which equates to approximately € 7.5 / day extra, considering our estimate of the kiosk's potential to make money.
Do a Cost Analysis Step 5 Step 5. Add up and compare the costs and benefits of the project
This is the crux of a CBA. Finally, we determine whether the benefits outweigh the costs. Subtract current costs from current benefits, then add all the costs made once to get a sense of the size of the initial investment needed to get started on the project. With this information, you should be able to determine if a project will be profitable and achievable.
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Let's compare the costs and benefits of opening a second lemonade stand:
- Running costs: 20 € / day (equipment) + 40 € / day (wages) = 60 € / day
- Current benefits: 120 € / day (income) + 7.5 € / day (extra half hour) + 2.5 € / day (savings on lemons) = 130 € / day
- Costs paid once: € 160 (closing of the first kiosk for one day) + € 80 (problems in the supply chain) + € 80 (blender) + € 15 (portable refrigerator) + € 20 (wood, cardboard) = 355€
- So, with an initial investment of € 355, we expect to make around € 130 - € 60 = 70 € / day. Not bad.
Do a Cost Analysis Step 6 Step 6. Calculate a return time for the initiative
The faster a project can pay for itself, the better. Considering the totals of costs and benefits, determine how long it will take to pay back the expected costs of the initial investment. In other words, divide the cost of the initial investment by the daily, weekly, monthly income, to calculate how many days, weeks, months it will take to pay back the initial investment and start generating a profit.
Our hypothetical project has an initial cost of € 355 and is estimated to generate € 70 / day. 355/70 = approximately 5. We know, therefore, assuming that our estimates are correct, that the new kiosk will pay the costs after about 5 days of operation. As the kiosks are open on weekends, this equates to approximately 2-3 weeks
Do a Cost Analysis Step 7 Step 7. Use the ACB to inform your decision on whether to pursue the project
If the expected benefits clearly outweigh the costs and the project can pay off the initial investment after a reasonable period, it is advisable to consider carrying out the project. If, on the other hand, it is not clear that a project will generate an extra profit or that it can pay off the expenses in a reasonable period of time, it will be better to reconsider the project or leave it alone altogether.
According to our CBA, our new kiosk appears to be a safe deal. It is expected to pay off after a few weeks and thereafter to generate a profit. Summer lasts for several months, so with a little luck, in the long run we will be able to make more money with two kiosks instead of just one
Advice
- Calculate the value of an intangible item using the possible cost (or return) of the intangible and the statistical probability that it will be realized. For example, a customer might send you a person they recommended you to, giving your business an extra $ 20 net. The statistical probability that a customer will send you a referral is 30 percent. This results in a cost-benefit analysis value of $ 6 for that recommendation.
- Each initiative has different costs and benefits. Try to consider everything when making the list of expected quantities. Remember that even the smallest things matter.
