Project Management Guide
What Is Cost Benefit Analysis in Project Management?
Managing your project simply based on gut or instinct is not going to cut it. Seasoned managers know that in order for their project management to be successful, they'll need to find ways to minimize risks, drive decision-making using hard data, and maximize opportunities for growth.
How can this be done? We have three words for you: Cost Benefit Analysis (CBA).?In this guide, we will look at how you can leverage this all-powerful tool. Let's jump right in.
What is Cost Benefit Analysis?
Starting with the very basics, here's a quick run-down of what cost benefit analysis entails and its defining characteristics:
- It empowers project managers to evaluate the cost and benefits of your project proposal.
- Project managers make use of project expenses and tangible benefits to analyze the benefits of the project post successful execution.
- It allows managers to calculate the return on investment (ROI), payback period,?internal rate of return (IRR), and net present value (NPV). Post this, the difference between the costs and benefits from taking action is calculated.
- As a thumb rule, if the cost is equal to or less than 50% of the benefits and the payback period is less than a year, then the project is worth undertaking.
Now that you have a basic understanding of the Cost Benefit Analysis, let's look at its overall goals and purpose.
Cost Benefit Analysis: Top-7 End-Goals & Purpose
There are seven end-goals of the cost benefit analysis in project management:
- To navigate and understand the various paths (such as tasks, investments, business needs, and so on) to take in a project via a systemic approach.
- To leverage options and gauge the ideal approach to boost customer satisfaction, achieve project goals and objectives, and of course, save on investment.
- To figure out if the project is feasible by understanding whether its benefits outweigh costs.
- To assess the benefits, costs, and profits of a project in an unbiased manner.
- To act as a benchmark for comparing projects based on project expense, project benefits, and project costs.
- To get stakeholder support if the project is proven to be feasible and profitable.
- To easily and seamlessly evaluate and control your project’s progress.
Moving on, let's look at the cost benefit analysis process.
Cost Benefit Analysis: A Step-by-Step Process
The concept of CBA came into existence thanks to Jules Dupuit, a French engineer, who spearheaded the process in 1848. He wanted to evaluate the feasibility of a construction project by understanding how much people were willing to pay for it.?
So here what the CBA process involves, which includes the following ten steps:
Step 1: Understanding the Goals and Objectives of the Project
This is a pivotal step that determines if the project is worth the effort. In other words, it will help you to understand what it is that you are trying to achieve.
Step 2: Gauging the Alternatives
Another vital step, the idea here, is to compare your project with others to understand what the best path forward is.
Step 3: Who are the Stakeholders?
This step involves listing out all the key stakeholders in the project. You can use the RACI matrix (responsible, accountable, consulted, and informed) to organize your team and understand which stakeholder needs to know what so that everyone is ultimately on the same page.
Step 4: Zeroing in on the Measurements
Next, you'll need to figure out the metrics to use to measure the costs and benefits. You'll also need to think about how to report on those metrics.?
Step 5: Understanding the Outcome of Costs and Benefits
Once you have analyzed the costs (think: cost of labor, overhead expenses, potential risks, lost opportunity costs, etc.) and benefits (such as revenue from sales, improved customer satisfaction, competitive advantage, greater market share, etc.) of the project, the next step is to map them to a specific time period.
Step 6: Converting Costs and Benefits to a Common Currency
The next logical step is to convert the costs and benefits to the same currency to ensure that your comparison is accurate and reliable.
Step 7: What is the Discount Rate??
This helps you to understand whether the people will be more willing to pay for the benefits in the future, and how much?
Step 8: Understanding the Net Present Value of the Project Options
Next, you'll need to measure the profit. This is calculated by subtracting the present values of cash outflows from the present values of cash inflows within a specific time period.
Step 9: What Is the Sensitivity Analysis?
In this step, you'll determine the risks and uncertainties in your projections. You can use the probability theory to showcase how the results respond to the parameter alterations.
Step 10: How Should You Proceed?
Once you have the real-time data in hand, you can make an informed decision in this final step and go ahead with the option that is recommended by the analysis. Next, let's understand some of the most important questions to ask when evaluating the CBA.
Evaluating the Cost Benefit Analysis: Top Questions to Ask
When you're evaluating the data, it helps to account for the following factors to better gauge the positive and negative impact of a project:
- What are the short-term and long-term effects of the project on the users and non-users?
- What kind of externality effects should you keep in mind?
- What are the social benefits?
- Are you applying the relevant costs and benefits commonly?
- Are you converting future expected costs and benefits into current rates?
- Are you considering the risks and uncertainties when evaluating the CBA of a project?
Finally, it is time to look at some of the limitations of the CBA process.
Primary Limitations of Cost Benefit Analysis
- Impact of inaccurate data: Your CBA is only as accurate as the data you input in the process. In other words, accurate estimates lead to reliable results.
- Differing project information: Sometimes, project managers end up relying on historical data collected from past projects and market benchmarks, which can differ in terms of the end goal, function, size, etc. This can lead to inaccurate results.
- Not useful for long-term projects: This process is best suited for smaller to mid-sized projects that can be completed quickly. For larger projects that take more time to complete, it can become difficult to consider external factors such as inflation, interest rates, etc., leading to inaccurate analysis. In such a case, it helps to make use of the NPV and IRR methods.
The Bottom Line
Long story short, if you wish to determine if the project is worth undertaking in terms of financial feasibility, you need to engage in a cost benefit analysis. You can think of it as an integral tool or a business process that sums up the benefits of a project and subtracts the associated costs.
Instead of making mental lists, engage in this data-backed, foolproof method to be 100% certain that your next project will be an astounding success.