It may be challenging to learn about Cost Benefit Analysis quickly. However, if you review the questions and answers listed below you will gain a little more understanding since these are commonly asked questions and the answers are based on wide experience.
When dealing with decisions using Cost Benefit techniques it is very important to follow the proven principles. The health of your company and your reputation depend on it. If these rules are not followed then your decisions could be flawed.
Let's start, shall we?
Question #1. Is this technique suitable for the small business owner?
Yes. The theory works equally as well for small business as it does for big business and government.
Cost Benefit Analysis is a decision-making technique that assesses the positive outcomes (benefits) as well as the negative outcomes (costs) of different decision alternatives. The trick is to make its implementation easy for the small businessperson.
Once you have basic knowledge of the theory and can enter data into a spreadsheet then the rest is not too difficult.
Question #2. Is this all I need to make better decisions?
No. Cost Benefit Analysis is a tool to assist in making better financial decisions. It is not an end in itself. However, part of the Cost Benefit process requires that you think widely on all options before making a final decision. This is often where most people fail in their decision-making attempts.
Cost Benefit Analysis is also very skilful at providing a single viability output for each competing option, making comparisons objective and easy.
Question #3. What do I include as the Costs and the Benefits?
Costs. All costs attributable to the project are to be included. Some of these are listed below:
- Asset Costs (both Capital and ongoing)
- Supply costs for purchased items
- Extra administrative effort required to manage project
- Delivery costs if to your account
- Replacement of assets in future years
- Tender preparation costs
- Any specialised tooling associated with the project
Revenue. Revenue can only be attributed to a project if it were not received were the project not to go ahead.
Asset Disposal and Residual Values. Some assets may be retired prior to the end of their useful lives or may be salvaged at the end of the project. This value is to be included in the cash flows (less the costs associated with their sale or disposal).
Cost Savings. All cost savings attributable to the project are to be included. Wage and salary cost savings must include their overheads and on-costs.
Question #4. How do I treat non-financial costs and benefits?
Since only cash transactions (both costs and benefits) are included in Cost Benefit models, non-financial costs and benefits are usually described by way of notes.
If the Benefit Cost Ratio is = to 1 or > 1 then the use of non-financial costs and benefits would not be required since the project is already VIABLE. Normally these non-financial costs and benefits would be included when comparing competing options whose Benefit Cost Ratio is close to each other.
Question #5. How can I test my assumptions?
You are best placed to make assumptions based on your own experience and judgement. However, you can use a technique to show others how robust your assumptions really are. This technique is called Sensitivity Analysis.
This technique is important to understand because you have made many assumptions in your analysis. These could have been, for instance, the level of new income generated, the savings generated or the residual value of the asset at the end of the project life. These assumptions are at the heart of your analysis and have contributed to your final Benefit Cost Ratio outcome.
Since the future cannot be accurately predicted there is a high probability that some of your assumptions may prove incorrect.
Using this technique will add conviction and weight to your proposal by showing how changes to costs and benefits affect the Benefit Cost Ratio. Do small changes move the project from VIABLE to UNVIABLE?
Question #6. How can I be sure that the project is VIABLE?
You have made your assumptions based on your project knowledge and experience. You have constructed the model that shows the project to be VIABLE. If you have followed the proven principles it should work out OK. Once the project has been authorised it is important to ensure that the assumptions are correct and in fact are deliverable.
To ensure this happens follow up on these items:
- Any labour savings must be delivered - re-assign affected resources
- Cost savings due to process changes must be acted upon swiftly
- Increased revenue from price rises must be implemented urgently
A Post Completion Review undertaken a year from the project's implementation will show you if all or some of your assumptions proved correct. It will also teach lessons on how this could done more successfully next time rather than making the same mistakes again.
Question #7. How can I implement this technique in my company?
There are a number of ways as follows:
- Use Cost Benefit Analysis yourself in a pilot project
- Convince the CEO of its benefits to the company and use that authority
- Use Cost Benefit Analysis in a specific business unit
All of these ways require a thorough understanding of the theory, the reasons for its implementation and the expected payoffs.
A training program would need to be undertaken so that all those involved understood the technique.
Question #8. Why does it have to include NPV to account for the time value of money?
Typically the life of the assets, or the decision being made, will have a financial impact over more than 1 year. This is usually 3 - 5 years (computers, software, factory machinery), 20 years for some large electrical equipment and even up to 100 years for underground pipes as used in water and sewer reticulation.
Inflation, year by year, reduces the buying power of the dollar causing us to spend more each year in dollar terms to purchase the same item. So it is with projects whose life span is more than one year.
Costs and benefits that occur in year 3 or 4 of the project would not have the same impact as if they occurred in year one.
The Benefit Cost Ratio and the final decision regarding VIABILITY could be completely wrong if NPV is not used in the model.
Question #9. Are there any limits to its applicability?
Not really, as long as you are dealing with financial costs and benefits. It has application to large and small decisions, complex and simple, long lived and short lived assets, also profit based and government and charities.
There are some general limitations:
Subjectivity - It is quite unlikely that two analysts working separately will estimate exactly the same Cost Benefit Ratio number. There are many variables that can be treated slightly differently, some of which are listed below:
- Estimation of physical and/or economic life of the asset/project
- Estimates of costs/benefits of environmental protection
- The choice of discount rates (the rates illustrated above are indicative of a range which could be applicable)
- The value of benefits can be different for different groups in society (i.e. the value of a $ to the poor section of the community is different to that of the affluent class)
Political Decision Making - The necessity of making political judgements on the viability of the project (timing of elections, regional loyalties) can sway an outcome. Also decision-makers are not consistent over space and time.
First Round Effects - We would normally only include the effects that are directly attributable to the project going ahead. We would not, for instance, include the increased community agricultural output generally due to a project going ahead. This would only be justified if the sector was originally under-employed.
Question #10. How can this technique actually help me?
There are many ways - some are listed below:
- Increases your confidence knowing you have used a proven reliable method.
- Having thought of all the options for solving the problem you can present your proposal knowing you have the answers.
- Using this technique will ensure you gain recognition and more opportunities for advancement
- Once the company sees the benefits of this technique it may wish you to be the trainer of other staff or the implementation champion - more opportunities for you.
- This technique will you save time in project assessment and ranking of competing proposals.
Bruce Hokin is an experienced accountant (FCPA) specializing in Cost Benefit Analysis. You can find more of his in-depth FREE articles, FREE Newsletter and e-zines at his website. To sign up for his downloadable Cost Benefit Analysis training program "5 Steps to Cost Benefit Mastery" just go to his website. You could be using this technique in under 2 hours! Available at www.thecostbenefitcoach.com
Tuesday, April 3, 2007
10 Critical Benefits You Receive by Using Cost Benefit Analysis
If you are called upon to make financial decisions you may find it difficult sometimes to confidently choose the best proposal. Using Cost Benefit Analysis can help.
When dealing with decisions using Cost Benefit techniques it is very important to follow the proven principles. The health of your company and your reputation depend on it. If these rules are not followed then your decisions could be flawed.
Let's start, shall we?
Benefit #1. You can compare competing projects quickly and accurately - saving you time and effort.
Cost Benefit Analysis weighs the total expected costs and compares them to the total expected benefits of one or more actions. The outcome of Cost Benefit Analysis is a Benefit Cost Ratio that is used to compare and rank competing investment options.
Once you apply these techniques you will quickly be able to compare and rank projects with confidence knowing that governments and large corporations use these proven principles.
Benefit #2. You can quickly determine whether a project may be VIABLE or UNVIABLE - quickly cutting out unviable options thereby saving you time and effort.
As mentioned above, Cost Benefit Analysis compares the costs and benefits of competing projects and produces a score (Benefit Cost Ratio) which if less than 1 shows that the project is UNVIABLE (all other things being equal).
This can quickly weed out the projects that will not make the cut, saving time and effort for you and others charged with considering these projects and making a final recommendation.
Benefit #3. You will be noticed and you will gain increased recognition if you use this technique correctly - more opportunities for you.
Since this powerful, proven technique can save discussion time, provide more accuracy and confidence, it will be seen as a real improvement. If you champion its introduction you will be noticed and gain recognition.
Benefit #4. You will be able to more confidently join or lead asset expenditure review discussions - more recognition and opportunities for you.
Once you learn and apply this method you can join in discussions at higher levels and feel confident that your skills can add value to the deliberations. Your input will be recognised and appreciated.
Benefit #5. Learning this very marketable technique will provide you with more options in your future.
There are many ways you can apply these techniques.
You could train others in the skill - both to internal and also to external clients.
You could be the assessor of the methodology PRIOR to projects being reviewed by senior management. This will save them time and frustration if they know that someone knowledgeable has already OK'd the maths and reviewed the assumptions for reasonableness.
You may wish to apply for more senior roles in your current employment or try out in other companies.
Benefit #6. You can apply these skills across small to large projects - making you more versatile.
The Cost Benefit principles can be used for projects as small as a PC replacement to underground assets that form part of large multi-billion capital works programs.
Your Cost Benefit Analysis skills are just as useful at either end of the scale.
Benefit #7. You will become recognised as the authority on this subject - more options for you.
Once you learn the theory and can present your proposal with confidence you will be recognised as the authority on this subject. Others will come to you for assistance seeking guidance for their projects.
Benefit #8. You can be sure that your decisions can withstand external scrutiny - saving you worry and concern.
The principles underpinning Cost Benefit Analysis have been in use since the 1960s by both government and big business. As long as you learn these principles from a recognised source, and apply them correctly, you can be confident that your analysis can withstand internal and external scrutiny.
Benefit #9. This methodology is scalable across small to large businesses.
Successful implementation across the business can only add to your marketable skill set meaning more opportunities for you. This skill could lead to consulting work for external clients - be they large or small - or starting your own Cost Benefit consulting business.
Benefit #10. Once this methodology is implemented it can significantly reduce the time taken to decide on competing projects -saving you time and frustration.
If this method is implemented for all investment proposals across the company then the comparison and choice amongst competing proposals is simplified. All other things being equal the project with the highest Benefit Cost Ratio should be the first to be authorized. The value of the business will increase the most by implementing the project with the highest Benefit Cost Ratio.
Bruce Hokin is an experienced accountant (FCPA) specializing in Cost Benefit Analysis. You can find more of his in-depth FREE articles, FREE Newsletter and e-zines at his website. To sign up for his downloadable Cost Benefit Analysis training program "5 Steps to Cost Benefit Mastery" just go to his website. You could be using this technique in under 2 hours! Available at www.thecostbenefitcoach.com
When dealing with decisions using Cost Benefit techniques it is very important to follow the proven principles. The health of your company and your reputation depend on it. If these rules are not followed then your decisions could be flawed.
Let's start, shall we?
Benefit #1. You can compare competing projects quickly and accurately - saving you time and effort.
Cost Benefit Analysis weighs the total expected costs and compares them to the total expected benefits of one or more actions. The outcome of Cost Benefit Analysis is a Benefit Cost Ratio that is used to compare and rank competing investment options.
Once you apply these techniques you will quickly be able to compare and rank projects with confidence knowing that governments and large corporations use these proven principles.
Benefit #2. You can quickly determine whether a project may be VIABLE or UNVIABLE - quickly cutting out unviable options thereby saving you time and effort.
As mentioned above, Cost Benefit Analysis compares the costs and benefits of competing projects and produces a score (Benefit Cost Ratio) which if less than 1 shows that the project is UNVIABLE (all other things being equal).
This can quickly weed out the projects that will not make the cut, saving time and effort for you and others charged with considering these projects and making a final recommendation.
Benefit #3. You will be noticed and you will gain increased recognition if you use this technique correctly - more opportunities for you.
Since this powerful, proven technique can save discussion time, provide more accuracy and confidence, it will be seen as a real improvement. If you champion its introduction you will be noticed and gain recognition.
Benefit #4. You will be able to more confidently join or lead asset expenditure review discussions - more recognition and opportunities for you.
Once you learn and apply this method you can join in discussions at higher levels and feel confident that your skills can add value to the deliberations. Your input will be recognised and appreciated.
Benefit #5. Learning this very marketable technique will provide you with more options in your future.
There are many ways you can apply these techniques.
You could train others in the skill - both to internal and also to external clients.
You could be the assessor of the methodology PRIOR to projects being reviewed by senior management. This will save them time and frustration if they know that someone knowledgeable has already OK'd the maths and reviewed the assumptions for reasonableness.
You may wish to apply for more senior roles in your current employment or try out in other companies.
Benefit #6. You can apply these skills across small to large projects - making you more versatile.
The Cost Benefit principles can be used for projects as small as a PC replacement to underground assets that form part of large multi-billion capital works programs.
Your Cost Benefit Analysis skills are just as useful at either end of the scale.
Benefit #7. You will become recognised as the authority on this subject - more options for you.
Once you learn the theory and can present your proposal with confidence you will be recognised as the authority on this subject. Others will come to you for assistance seeking guidance for their projects.
Benefit #8. You can be sure that your decisions can withstand external scrutiny - saving you worry and concern.
The principles underpinning Cost Benefit Analysis have been in use since the 1960s by both government and big business. As long as you learn these principles from a recognised source, and apply them correctly, you can be confident that your analysis can withstand internal and external scrutiny.
Benefit #9. This methodology is scalable across small to large businesses.
Successful implementation across the business can only add to your marketable skill set meaning more opportunities for you. This skill could lead to consulting work for external clients - be they large or small - or starting your own Cost Benefit consulting business.
Benefit #10. Once this methodology is implemented it can significantly reduce the time taken to decide on competing projects -saving you time and frustration.
If this method is implemented for all investment proposals across the company then the comparison and choice amongst competing proposals is simplified. All other things being equal the project with the highest Benefit Cost Ratio should be the first to be authorized. The value of the business will increase the most by implementing the project with the highest Benefit Cost Ratio.
Bruce Hokin is an experienced accountant (FCPA) specializing in Cost Benefit Analysis. You can find more of his in-depth FREE articles, FREE Newsletter and e-zines at his website. To sign up for his downloadable Cost Benefit Analysis training program "5 Steps to Cost Benefit Mastery" just go to his website. You could be using this technique in under 2 hours! Available at www.thecostbenefitcoach.com
Do You Make These 10 Mistakes When Making Financial Decisions?
Making decisions is what managers are paid to do. However, the ramifications of these decisions can have a marked positive or
negative outcome on the company. Not to mention the manager's
prospects as well.
The article covers just a few of the mistakes made and why they should be avoided.
Mistake #1. Not exploring all options.
It is human nature to want to think about the problem quickly, make a decision (instead of looking for the best decision) as soon as possible and move on.
There are many tools available to assist in thinking creatively to ensure all possible options are canvassed PRIOR to the decision being made.
For Example: If a decision is to be made regarding the company's business systems, close study would need to be given to ensure all feasible software providers were involved. Not only would you need to look at software providers but also hardware sources and bureau services. Also, will the future direction of the business mean that simply replacing “like with like” be suitable? Also is the ”do nothing” option viable?
Mistake #2. Not assessing the options correctly.
If you deal with Mistake #1 and generate many options, how are you going to know which options are worth pursuing? You need a recognised, tested and proven method to assess these options so that the best ones can be chosen for implementation.
Cost Benefit Analysis is the proven, accepted method used to make these choices. The Cost Benefit method is easy to understand and implement.
Cost Benefit Analysis is used around the world by big business and many governments when investment decisions and funding allocation questions need a resolution.
Cost Benefit Analysis provides a clear, unambiguous method that shows which proposal will provide the best Benefit Cost Ratio and should be funded (all other things being equal).
Mistake #3. Not funding the best option.
Once the best option is decided upon then you need the confidence to fund that decision. Cost Benefit Analysis models clearly outline the assumptions, the costs, benefits, and the method of adjusting for changes in purchasing power over time.
You can be confident in funding the decision if all the elements of the analysis are correct and agreed upon.
The final answer from the model is the Benefit Cost Ratio. Benefit Cost Ratios of greater than 1 also translate into increased shareholder value - a must for successful companies.
The opposite is also true. Benefit Cost Ratios of less than 1 will destroy shareholder value. You would not normally fund decisions with this result.
Mistake #4. Wasting time at meetings debating the method - not the proposal.
Since Cost Benefit Analysis provides clear assumptions, costs, benefits and a final answer, the time taken discussing the method is reduced. This is especially marked if this method is agreed across the company BEFORE it is used.
More time can then be applied to discussing the data and the assumptions, not the method, allowing managers to spend more time on other tasks.
Mistake #5. Not standardising this method across the company.
There are many benefits to be gained by training appropriate staff and implementing this method across the company for all financial decisions. Some of these are listed below:
- Shortens decision-making time
- Reduces arguments in financial decision meetings
- Subjectivity is reduced
- Sign-off by responsible managers is made easier
- More time available for CEO to plan and direct
Mistake #6. Not selling the final decision appropriately.
Once the decision has been made to fund a particular proposal, it is important to sell this to the interested stakeholders. These stakeholders could be employees, unions, shareholders, the press, other executives, special interest groups or funding providers.
Selling a decision that used Cost Benefit principles is easier. The method is clear, tested, proven and easy to understand. This makes it more likely to be accepted.
Mistake #7. Using methods that do not include ALL Cost Benefit components.
There are certain elements to Cost Benefit Analysis that are critical to its success and confident decisions. These are listed below:
- Net Present Value
- Appropriate Discount Rates
- Clear explanation of assumptions
- Use of Benefit Cost Ratio
- Thinking widely on all options including “do nothing”
- Inclusion of non-financial benefits
- "Cradle to Grave” view of costs and benefits
If you are assessing other Cost Benefit texts or sites make sure all these items are included.
Mistake #8. Not reviewing the decision once it is implemented.
The decision has been made and the proposal funded; it has been sold to the stakeholders and it has been implemented. It has been operating for at least a year. Now what?
It is time to review the decision, its implementation, the model's assumptions and the decision process. These aspects are made easier since all the critical aspects of the proposal were included in the initial deliberations.
This review can take into the following items to see if lessons can be learned so the same mistakes (if there are any) are not made on the next proposal:
- Did the proposed costs and benefits actually occur?
- Were the original model assumptions correct?
- Could the decision process be improved?
- Could others have assisted in the decision process?
- What lessons can we learn?
Mistake #9. Not learning from the past mistakes.
Had this method been implemented for past decisions then lessons learnt from past mistakes could be applied to the decisions at hand. It is important for the health of the business to implement these principles now - before other mistakes and sub-optimal decisions are made.
Mistake #10. Not training all potential decision-makers in the correct method.
It is important to ensure that all potential decision-makers are trained in the same method. It will only cause friction if these are differing ideas of the correct method.
I have found that it works best if the CEO can be convinced then he/she sells/directs it to the other decision-makers as the only way to present proposals in future.
Bruce Hokin is an experienced accountant (FCPA) specializing in Cost Benefit Analysis. You can find more of his in-depth FREE articles, FREE Newsletter and e-zines at his website. To sign up for his downloadable Cost Benefit Analysis training program "5 Steps to Cost Benefit Mastery" just go to his website. You could be using this technique in under 2 hours! Available at www.thecostbenefitcoach.com
negative outcome on the company. Not to mention the manager's
prospects as well.
The article covers just a few of the mistakes made and why they should be avoided.
Mistake #1. Not exploring all options.
It is human nature to want to think about the problem quickly, make a decision (instead of looking for the best decision) as soon as possible and move on.
There are many tools available to assist in thinking creatively to ensure all possible options are canvassed PRIOR to the decision being made.
For Example: If a decision is to be made regarding the company's business systems, close study would need to be given to ensure all feasible software providers were involved. Not only would you need to look at software providers but also hardware sources and bureau services. Also, will the future direction of the business mean that simply replacing “like with like” be suitable? Also is the ”do nothing” option viable?
Mistake #2. Not assessing the options correctly.
If you deal with Mistake #1 and generate many options, how are you going to know which options are worth pursuing? You need a recognised, tested and proven method to assess these options so that the best ones can be chosen for implementation.
Cost Benefit Analysis is the proven, accepted method used to make these choices. The Cost Benefit method is easy to understand and implement.
Cost Benefit Analysis is used around the world by big business and many governments when investment decisions and funding allocation questions need a resolution.
Cost Benefit Analysis provides a clear, unambiguous method that shows which proposal will provide the best Benefit Cost Ratio and should be funded (all other things being equal).
Mistake #3. Not funding the best option.
Once the best option is decided upon then you need the confidence to fund that decision. Cost Benefit Analysis models clearly outline the assumptions, the costs, benefits, and the method of adjusting for changes in purchasing power over time.
You can be confident in funding the decision if all the elements of the analysis are correct and agreed upon.
The final answer from the model is the Benefit Cost Ratio. Benefit Cost Ratios of greater than 1 also translate into increased shareholder value - a must for successful companies.
The opposite is also true. Benefit Cost Ratios of less than 1 will destroy shareholder value. You would not normally fund decisions with this result.
Mistake #4. Wasting time at meetings debating the method - not the proposal.
Since Cost Benefit Analysis provides clear assumptions, costs, benefits and a final answer, the time taken discussing the method is reduced. This is especially marked if this method is agreed across the company BEFORE it is used.
More time can then be applied to discussing the data and the assumptions, not the method, allowing managers to spend more time on other tasks.
Mistake #5. Not standardising this method across the company.
There are many benefits to be gained by training appropriate staff and implementing this method across the company for all financial decisions. Some of these are listed below:
- Shortens decision-making time
- Reduces arguments in financial decision meetings
- Subjectivity is reduced
- Sign-off by responsible managers is made easier
- More time available for CEO to plan and direct
Mistake #6. Not selling the final decision appropriately.
Once the decision has been made to fund a particular proposal, it is important to sell this to the interested stakeholders. These stakeholders could be employees, unions, shareholders, the press, other executives, special interest groups or funding providers.
Selling a decision that used Cost Benefit principles is easier. The method is clear, tested, proven and easy to understand. This makes it more likely to be accepted.
Mistake #7. Using methods that do not include ALL Cost Benefit components.
There are certain elements to Cost Benefit Analysis that are critical to its success and confident decisions. These are listed below:
- Net Present Value
- Appropriate Discount Rates
- Clear explanation of assumptions
- Use of Benefit Cost Ratio
- Thinking widely on all options including “do nothing”
- Inclusion of non-financial benefits
- "Cradle to Grave” view of costs and benefits
If you are assessing other Cost Benefit texts or sites make sure all these items are included.
Mistake #8. Not reviewing the decision once it is implemented.
The decision has been made and the proposal funded; it has been sold to the stakeholders and it has been implemented. It has been operating for at least a year. Now what?
It is time to review the decision, its implementation, the model's assumptions and the decision process. These aspects are made easier since all the critical aspects of the proposal were included in the initial deliberations.
This review can take into the following items to see if lessons can be learned so the same mistakes (if there are any) are not made on the next proposal:
- Did the proposed costs and benefits actually occur?
- Were the original model assumptions correct?
- Could the decision process be improved?
- Could others have assisted in the decision process?
- What lessons can we learn?
Mistake #9. Not learning from the past mistakes.
Had this method been implemented for past decisions then lessons learnt from past mistakes could be applied to the decisions at hand. It is important for the health of the business to implement these principles now - before other mistakes and sub-optimal decisions are made.
Mistake #10. Not training all potential decision-makers in the correct method.
It is important to ensure that all potential decision-makers are trained in the same method. It will only cause friction if these are differing ideas of the correct method.
I have found that it works best if the CEO can be convinced then he/she sells/directs it to the other decision-makers as the only way to present proposals in future.
Bruce Hokin is an experienced accountant (FCPA) specializing in Cost Benefit Analysis. You can find more of his in-depth FREE articles, FREE Newsletter and e-zines at his website. To sign up for his downloadable Cost Benefit Analysis training program "5 Steps to Cost Benefit Mastery" just go to his website. You could be using this technique in under 2 hours! Available at www.thecostbenefitcoach.com
9 Profitable Ways Accountants Can Boost Their Business Using Cost Benefit Analysis
Accountants are well suited to making extra income by using Cost Benefit Analysis. The 9 ways shown in the article will make it easy to add these elements to your business. Cost Benefit Analysis can assist your clients and boost your profit.
When dealing with decisions using Cost Benefit techniques it is very important to follow the proven principles. The health of your company and your reputation depend on it. If these rules are not followed then your decisions could be flawed.
Let's start, shall we?
Profitable Way #1. Making Better Asset Purchase Decisions for Your Company
Cost Benefit Analysis is very useful when deciding between competing financial outcomes. Do we purchase this new asset or that one? Do we proceed with this investment in new technology or continue as normal? Is it time to replace an ageing asset yet, or should it be kept longer?
Profitable Way #2. Making Better Asset Purchase Recommendations for Your Clients.
All the comments above relate just as much to you as to your clients- even more so, since there may be repercussions if your recommendations are flawed.
Think of the benefits to the business if you can show your clients a proven easy-to-understand system used by many governments and large corporations world-wide for making better financial decisions.
This methodology will withstand external scrutiny - it has done so many times in the past.
Profitable Way #3. Audit Client's Cost Benefit Methodology.
Another separate opportunity is for you to offer to “audit” your clients' project development plans and spreadsheets for mathematical correctness as well as the validity and strength of their assumptions.
Large companies will appreciate an objective review of their project methodology. It can add weight to their funding applications also.
Profitable Way #4. Consulting to Clients on How to Spend their Scarce Investment Capital on Competing Projects.
Cost Benefit Analysis is very useful in ranking projects based on their Benefit Cost Ratio results. The project with the highest Benefit Cost Ratio should be authorised first since it will increase the company's value the most (all other things being equal).
Profitable Way #5. Offer These Services to Charities
Not-for-Profits and Charities need to show their stakeholders/shareholders that their financial decisions are based on proven principles. They may not have sufficient spare funds to undertake this analysis themselves. However, you could offer to audit and consult in the area of Cost Benefit Analysis, gratis, in return for some acknowledgement in their Annual Reports.
Profitable Way #6. Implement this Method Across Client Companies
Once you learn the principles of Cost Benefit Analysis you will appreciate that most companies would benefit from an “across the board” implementation of this method. This could mean extensive training and developing an implementation strategy. More business opportunities for you.
Profitable Way #7. Advertise Cost Benefit Analysis Services in Newsletters and Client Correspondence.
This service can help in setting your company apart from your competitors. Why not advertise this expertise in your newspaper advertisements?
Profitable Way #8. Training in Cost Benefit Analysis
Running training programs in Cost Benefit Analysis for many invited clients can lead to further business, both in implementation and other consulting work.
Profitable Way #9. Offer to Prepare Cost Benefit Analyses for Client Funding Proposals.
Cost Benefit Analysis is a powerful tool that can clearly show the benefits contained in the new proposal compared to the “do nothing” or other competing options. It can also show how soon the project will move from a net cost to net benefit position. Other measures of payback can still be included for reference purposes such as Payback, Internal Rate of Return and Net Present Value. It clearly shows the benefits received for each $ of cost expended.
Bruce Hokin is an experienced accountant (FCPA) specializing in Cost Benefit Analysis. You can find more of his in-depth FREE articles, FREE Newsletter and e-zines at his website. To sign up for his downloadable Cost Benefit Analysis training program "5 Steps to Cost Benefit Mastery" just go to his website. You could be using this technique in under 2 hours! Available at www.thecostbenefitcoach.com
When dealing with decisions using Cost Benefit techniques it is very important to follow the proven principles. The health of your company and your reputation depend on it. If these rules are not followed then your decisions could be flawed.
Let's start, shall we?
Profitable Way #1. Making Better Asset Purchase Decisions for Your Company
Cost Benefit Analysis is very useful when deciding between competing financial outcomes. Do we purchase this new asset or that one? Do we proceed with this investment in new technology or continue as normal? Is it time to replace an ageing asset yet, or should it be kept longer?
Profitable Way #2. Making Better Asset Purchase Recommendations for Your Clients.
All the comments above relate just as much to you as to your clients- even more so, since there may be repercussions if your recommendations are flawed.
Think of the benefits to the business if you can show your clients a proven easy-to-understand system used by many governments and large corporations world-wide for making better financial decisions.
This methodology will withstand external scrutiny - it has done so many times in the past.
Profitable Way #3. Audit Client's Cost Benefit Methodology.
Another separate opportunity is for you to offer to “audit” your clients' project development plans and spreadsheets for mathematical correctness as well as the validity and strength of their assumptions.
Large companies will appreciate an objective review of their project methodology. It can add weight to their funding applications also.
Profitable Way #4. Consulting to Clients on How to Spend their Scarce Investment Capital on Competing Projects.
Cost Benefit Analysis is very useful in ranking projects based on their Benefit Cost Ratio results. The project with the highest Benefit Cost Ratio should be authorised first since it will increase the company's value the most (all other things being equal).
Profitable Way #5. Offer These Services to Charities
Not-for-Profits and Charities need to show their stakeholders/shareholders that their financial decisions are based on proven principles. They may not have sufficient spare funds to undertake this analysis themselves. However, you could offer to audit and consult in the area of Cost Benefit Analysis, gratis, in return for some acknowledgement in their Annual Reports.
Profitable Way #6. Implement this Method Across Client Companies
Once you learn the principles of Cost Benefit Analysis you will appreciate that most companies would benefit from an “across the board” implementation of this method. This could mean extensive training and developing an implementation strategy. More business opportunities for you.
Profitable Way #7. Advertise Cost Benefit Analysis Services in Newsletters and Client Correspondence.
This service can help in setting your company apart from your competitors. Why not advertise this expertise in your newspaper advertisements?
Profitable Way #8. Training in Cost Benefit Analysis
Running training programs in Cost Benefit Analysis for many invited clients can lead to further business, both in implementation and other consulting work.
Profitable Way #9. Offer to Prepare Cost Benefit Analyses for Client Funding Proposals.
Cost Benefit Analysis is a powerful tool that can clearly show the benefits contained in the new proposal compared to the “do nothing” or other competing options. It can also show how soon the project will move from a net cost to net benefit position. Other measures of payback can still be included for reference purposes such as Payback, Internal Rate of Return and Net Present Value. It clearly shows the benefits received for each $ of cost expended.
Bruce Hokin is an experienced accountant (FCPA) specializing in Cost Benefit Analysis. You can find more of his in-depth FREE articles, FREE Newsletter and e-zines at his website. To sign up for his downloadable Cost Benefit Analysis training program "5 Steps to Cost Benefit Mastery" just go to his website. You could be using this technique in under 2 hours! Available at www.thecostbenefitcoach.com
5 Critical Items Never to be Included in Cost Benefit Analysis
Cost Benefit Analysis is a powerful management tool and must be carried out to accepted principles. If not, your reputation and the company could suffer. There are certain elements that should never be included in Cost Benefit Analysis. Some of these are listed in this article.
Let's start, shall we?
Critical Item #1. Sunk Costs
Irrecoverable cash outlays that occurred prior to the evaluation of the project are excluded, only the present and future costs/benefits are assessed. You cannot go back in time to add in past costs, only deal in the current and the future, as best you can.
Critical Item #2. Arbitrary Accounting Cost/Income Allocations
Depreciation - Depreciation is not a cash item. It relates to cash expended on capital purchases in previous periods. It is intended to show the decreasing value of the asset as time passes and as the asset ages through use or obsolescence.
To include depreciation in Cost Benefit Analysis, would be to double-count the expenditure. The decreasing value of the asset is shown by the difference in the purchase price and the eventual disposal or sales price at the end of its life.
Accruals - Accruals are an accounting method of moving costs and income to different years as compared to when the transaction actually occurred. In Cost Benefit Analysis, we are dealing only in cash transactions in the year they occurred. Accruals have no role here.
Critical Item #3. Price Changes Due to Inflation
The Discount Rate used in the model is designed to take account of inflation during the life of the project. The Discount Rate reduces the value of the costs and benefits as time progresses, just as inflation does. If inflation-based price changes were included in the analysis, then they would be double-counted.
Critical Item #4. Book Gains or Losses
Accountants use this method to take account of the fact that the value of the asset at time of disposal is not equal to the depreciated value in the company's books. This often happens, since it is not always possible to accurately predict the selling price or disposal value at the time of purchase when the life of the asset is longer than a year or two.
However, in Cost Benefit Analysis models the purchase price and the selling price are always clearly stated, so there is no need to adjust.
Critical Item #5. Loan Repayments
The use of the Discount Rate is designed to take account of the cost of financing the project whether in terms of interest rate (if the funds are borrowed) or return on equity (if the funds are provided by shareholders). The actual cash repayments on the loan have no place in this analysis. Neither does the interest component of the repayments.
Bruce Hokin is an experienced accountant (FCPA) specializing in Cost Benefit Analysis. You can find more of his in-depth FREE articles, FREE Newsletter and e-zines at his website. To sign up for his downloadable Cost Benefit Analysis training program "5 Steps to Cost Benefit Mastery" just go to his website. You could be using this technique in under 2 hours! Available at www.thecostbenefitcoach.com
Let's start, shall we?
Critical Item #1. Sunk Costs
Irrecoverable cash outlays that occurred prior to the evaluation of the project are excluded, only the present and future costs/benefits are assessed. You cannot go back in time to add in past costs, only deal in the current and the future, as best you can.
Critical Item #2. Arbitrary Accounting Cost/Income Allocations
Depreciation - Depreciation is not a cash item. It relates to cash expended on capital purchases in previous periods. It is intended to show the decreasing value of the asset as time passes and as the asset ages through use or obsolescence.
To include depreciation in Cost Benefit Analysis, would be to double-count the expenditure. The decreasing value of the asset is shown by the difference in the purchase price and the eventual disposal or sales price at the end of its life.
Accruals - Accruals are an accounting method of moving costs and income to different years as compared to when the transaction actually occurred. In Cost Benefit Analysis, we are dealing only in cash transactions in the year they occurred. Accruals have no role here.
Critical Item #3. Price Changes Due to Inflation
The Discount Rate used in the model is designed to take account of inflation during the life of the project. The Discount Rate reduces the value of the costs and benefits as time progresses, just as inflation does. If inflation-based price changes were included in the analysis, then they would be double-counted.
Critical Item #4. Book Gains or Losses
Accountants use this method to take account of the fact that the value of the asset at time of disposal is not equal to the depreciated value in the company's books. This often happens, since it is not always possible to accurately predict the selling price or disposal value at the time of purchase when the life of the asset is longer than a year or two.
However, in Cost Benefit Analysis models the purchase price and the selling price are always clearly stated, so there is no need to adjust.
Critical Item #5. Loan Repayments
The use of the Discount Rate is designed to take account of the cost of financing the project whether in terms of interest rate (if the funds are borrowed) or return on equity (if the funds are provided by shareholders). The actual cash repayments on the loan have no place in this analysis. Neither does the interest component of the repayments.
Bruce Hokin is an experienced accountant (FCPA) specializing in Cost Benefit Analysis. You can find more of his in-depth FREE articles, FREE Newsletter and e-zines at his website. To sign up for his downloadable Cost Benefit Analysis training program "5 Steps to Cost Benefit Mastery" just go to his website. You could be using this technique in under 2 hours! Available at www.thecostbenefitcoach.com
Do You Make These 10 Mistakes With Cost Benefit Analysis?
Financial decisions are very important to the health of any company. So it is critical that decisions are made using the best techniques available. Cost Benefit Analysis is designed to help you make the best financial decisions possible.
Now let's dive right in and list them out shall we?
Mistake #1: Not thinking widely enough to explore all feasible options.
First, a note about benefits - if you can provide a solution that provides more benefits than the current process, then not only do you benefit (hopefully in practical and emotional ways) but also the company profits, so do the shareholders and so does the economy. If more of these positive benefit decisions were being made daily by more and more people then we would all be better off!
It is human nature to want to think about the problem quickly, get to an answer (instead of a list of good answers) as soon as possible and move on.
This is the MAIN mistake that needs to be addressed before launching into the rest of the mistakes.
For Example: If a decision is to be made regarding the company's business systems, close study would need to be given to ensure all feasible software providers were involved. Not only would you need to look at software providers but also hardware sources and bureau services. Also, will the future direction of the business mean that simply replacing “like with like” be suitable? Also is the ”do nothing” option viable?
Mistake #2: Not using “Cradle to Grave” timeframe.
As the term implies, all costs and benefits associated with the project from the time the analysis begins (“birth”) to the sale (“death”) of the asset must be included. If this process is neglected, costs such as sale of assets and/or disposal of assets, site cleanup and site re-instatement may be omitted from the calculations that could provide an erroneous result (and maybe embarrassment to you as the project champion). In addition, this provides for all “birth” costs, such as new asset purchase costs, transport costs, site preparation costs and the sale of the old asset to be included in calculations. Don't neglect these - they can make a huge difference to the outcome.
Mistake #3: Not using Net Present Value to take account of the Time Value of Money.
Typically the life of the assets, or the decision being made, have an impact over more than 1 year. This is usually 3 - 5 years (computers, software, factory machinery), 20 years for some large electrical equipment and even up to 100 years for underground pipes as used in water and sewer reticulation.
As you would know, and as Howard Hughes said in 1937, “A million dollars is not what it used to be”. This is because inflation, year by year, reduces the buying power of the dollar causing us to spend more each year to purchase the same item. So it is with projects whose life span is more than one year.
(Let's say, that the interest rate is 5%, you would only need to deposit about $95 today to get $100 next year. Economists would say that, at a 5% discount rate, $100 next year has a present value of $95.) For longer periods of time, and/or higher discount rates, the effect is magnified.
Costs and benefits that occur in year 3 or 4 of the project would not have the same impact as if they occurred in year 1. There is a function within Excel that accounts for this so there is no real need to concern yourself with it too much here.
Suffice to say that transactions further into the future have less of a dollar impact than the current transactions. This must be included in your calculations.
Mistake #4: Including other than CASH transactions in the Costs and Benefits calculations.
Some practitioners use accounting terminologies such as Depreciation, Accruals or Deferrals in their Cost Benefit models. This is not correct. We are only dealing with the cash costs and benefits. This keeps the model:
- Easy to understand for non-accountants
- Free from any artificial spreading of costs and income that are not really
related to the period
It is important that the cash flow of costs and benefits are shown in the years they actually occur - since moving them into other years can increase or decrease their value due to the time value of money as discussed above. (A cash transaction occurs when there is a monetary transaction - either outflow or receipt.)
Mistake #5: Not considering the “Do Nothing” option.
Just because an asset is ageing or in need of repair, it does NOT necessarily mean that a replacement is the best use of the available resources. It could well be that this option continues to be the most feasible option. This option should always be considered and accounted for when thinking of ALL feasible options.
Mistake #6: Forgetting to include non-financial Costs and Benefits.
There are many benefits and costs that can be part of the decision process, which really do not have hard quantifiable values. Some of these could be:
- The cost of a human life (e.g. saved by installing traffic lights a school crossing)
- Damming of a river and the loss of habitat of many flora and fauna species
- Extra noise created as a result of road relocation
- Increasing obesity of school children and poor health outcomes
Another example of non-financial costs and benefits could be political affiliations/expediency that could sway a decision even though the Cost Benefit model shows this to be a less beneficial option than other options.
Mistake #7: Thinking that Cost Benefit Analysis is THE solution to the problem.
Cost Benefit Analysis and NPV are tools or techniques that assist in the decision or judgement. These processes are not an end in themselves. They are part of a suite of tools that /engineers/accountants/managers/business owners can call upon to assist in the making the final decision.
Mistake #8: Adding in Sunk Costs on the projects prior to the Cost Benefit Analysis being undertaken.
Costs that have been expended are NOT to be included since these have been made outside the view of your analysis. You cannot go back in time to add in past costs, only deal in the current and the future, as best you can.
Mistake #9: Not delivering on savings promised in the Cost Benefit Analysis proposal.
I have seen many Cost Benefit Analyses where the purchase of new computers or machinery has relied on (at least to some extent) the savings in labour. This is all well and good.
The project champion has ensured that ALL the labour costs were included (eg annual leave, superannuation, health care costs, public holidays and other loadings) but once the project had received the go-ahead he/she has omitted to make the labour savings by making the labour redundant or finding these employees gainful employment in other parts of the organization.
Another example is when machine hours have projected savings shown in the Cost Benefit Analysis model but due to internal politics the changes to operating procedures were not implemented once the project was implemented.
You will notice when building a Cost Benefit model that the Costs are reasonably easy to calculate since most of them have quoted prices or contracts etc. on which to rely. It is the Benefits that will cause most discussion and these need to be tied down tightly prior to the go-ahead being given.
It is really important to be certain of all your assumptions so that you can confidently argue the merits (and drawbacks) of the project.
Mistake #10: Not performing a Project Completion Review during the life of the project once it is implemented.
Unless this step is taken any lessons to be learned either by you or the organization are lost. Yes, it may cause some embarrassment if not all the benefits were not realised and some costs came in at more than planned. But that is not as important as repeating these “sins” again and again on subsequent projects. Make this part of the corporate culture and you will notice an improvement over time to your benefit and the benefit of the company and the economy.
Bruce Hokin is an experienced accountant (FCPA) specializing in Cost Benefit Analysis. You can find more of his in-depth FREE articles, FREE Newsletter and e-zines at his website. To sign up for his downloadable Cost Benefit Analysis training program "5 Steps to Cost Benefit Mastery" just go to his website. You could be using this technique in under 2 hours! Available at www.thecostbenefitcoach.com
Now let's dive right in and list them out shall we?
Mistake #1: Not thinking widely enough to explore all feasible options.
First, a note about benefits - if you can provide a solution that provides more benefits than the current process, then not only do you benefit (hopefully in practical and emotional ways) but also the company profits, so do the shareholders and so does the economy. If more of these positive benefit decisions were being made daily by more and more people then we would all be better off!
It is human nature to want to think about the problem quickly, get to an answer (instead of a list of good answers) as soon as possible and move on.
This is the MAIN mistake that needs to be addressed before launching into the rest of the mistakes.
For Example: If a decision is to be made regarding the company's business systems, close study would need to be given to ensure all feasible software providers were involved. Not only would you need to look at software providers but also hardware sources and bureau services. Also, will the future direction of the business mean that simply replacing “like with like” be suitable? Also is the ”do nothing” option viable?
Mistake #2: Not using “Cradle to Grave” timeframe.
As the term implies, all costs and benefits associated with the project from the time the analysis begins (“birth”) to the sale (“death”) of the asset must be included. If this process is neglected, costs such as sale of assets and/or disposal of assets, site cleanup and site re-instatement may be omitted from the calculations that could provide an erroneous result (and maybe embarrassment to you as the project champion). In addition, this provides for all “birth” costs, such as new asset purchase costs, transport costs, site preparation costs and the sale of the old asset to be included in calculations. Don't neglect these - they can make a huge difference to the outcome.
Mistake #3: Not using Net Present Value to take account of the Time Value of Money.
Typically the life of the assets, or the decision being made, have an impact over more than 1 year. This is usually 3 - 5 years (computers, software, factory machinery), 20 years for some large electrical equipment and even up to 100 years for underground pipes as used in water and sewer reticulation.
As you would know, and as Howard Hughes said in 1937, “A million dollars is not what it used to be”. This is because inflation, year by year, reduces the buying power of the dollar causing us to spend more each year to purchase the same item. So it is with projects whose life span is more than one year.
(Let's say, that the interest rate is 5%, you would only need to deposit about $95 today to get $100 next year. Economists would say that, at a 5% discount rate, $100 next year has a present value of $95.) For longer periods of time, and/or higher discount rates, the effect is magnified.
Costs and benefits that occur in year 3 or 4 of the project would not have the same impact as if they occurred in year 1. There is a function within Excel that accounts for this so there is no real need to concern yourself with it too much here.
Suffice to say that transactions further into the future have less of a dollar impact than the current transactions. This must be included in your calculations.
Mistake #4: Including other than CASH transactions in the Costs and Benefits calculations.
Some practitioners use accounting terminologies such as Depreciation, Accruals or Deferrals in their Cost Benefit models. This is not correct. We are only dealing with the cash costs and benefits. This keeps the model:
- Easy to understand for non-accountants
- Free from any artificial spreading of costs and income that are not really
related to the period
It is important that the cash flow of costs and benefits are shown in the years they actually occur - since moving them into other years can increase or decrease their value due to the time value of money as discussed above. (A cash transaction occurs when there is a monetary transaction - either outflow or receipt.)
Mistake #5: Not considering the “Do Nothing” option.
Just because an asset is ageing or in need of repair, it does NOT necessarily mean that a replacement is the best use of the available resources. It could well be that this option continues to be the most feasible option. This option should always be considered and accounted for when thinking of ALL feasible options.
Mistake #6: Forgetting to include non-financial Costs and Benefits.
There are many benefits and costs that can be part of the decision process, which really do not have hard quantifiable values. Some of these could be:
- The cost of a human life (e.g. saved by installing traffic lights a school crossing)
- Damming of a river and the loss of habitat of many flora and fauna species
- Extra noise created as a result of road relocation
- Increasing obesity of school children and poor health outcomes
Another example of non-financial costs and benefits could be political affiliations/expediency that could sway a decision even though the Cost Benefit model shows this to be a less beneficial option than other options.
Mistake #7: Thinking that Cost Benefit Analysis is THE solution to the problem.
Cost Benefit Analysis and NPV are tools or techniques that assist in the decision or judgement. These processes are not an end in themselves. They are part of a suite of tools that /engineers/accountants/managers/business owners can call upon to assist in the making the final decision.
Mistake #8: Adding in Sunk Costs on the projects prior to the Cost Benefit Analysis being undertaken.
Costs that have been expended are NOT to be included since these have been made outside the view of your analysis. You cannot go back in time to add in past costs, only deal in the current and the future, as best you can.
Mistake #9: Not delivering on savings promised in the Cost Benefit Analysis proposal.
I have seen many Cost Benefit Analyses where the purchase of new computers or machinery has relied on (at least to some extent) the savings in labour. This is all well and good.
The project champion has ensured that ALL the labour costs were included (eg annual leave, superannuation, health care costs, public holidays and other loadings) but once the project had received the go-ahead he/she has omitted to make the labour savings by making the labour redundant or finding these employees gainful employment in other parts of the organization.
Another example is when machine hours have projected savings shown in the Cost Benefit Analysis model but due to internal politics the changes to operating procedures were not implemented once the project was implemented.
You will notice when building a Cost Benefit model that the Costs are reasonably easy to calculate since most of them have quoted prices or contracts etc. on which to rely. It is the Benefits that will cause most discussion and these need to be tied down tightly prior to the go-ahead being given.
It is really important to be certain of all your assumptions so that you can confidently argue the merits (and drawbacks) of the project.
Mistake #10: Not performing a Project Completion Review during the life of the project once it is implemented.
Unless this step is taken any lessons to be learned either by you or the organization are lost. Yes, it may cause some embarrassment if not all the benefits were not realised and some costs came in at more than planned. But that is not as important as repeating these “sins” again and again on subsequent projects. Make this part of the corporate culture and you will notice an improvement over time to your benefit and the benefit of the company and the economy.
Bruce Hokin is an experienced accountant (FCPA) specializing in Cost Benefit Analysis. You can find more of his in-depth FREE articles, FREE Newsletter and e-zines at his website. To sign up for his downloadable Cost Benefit Analysis training program "5 Steps to Cost Benefit Mastery" just go to his website. You could be using this technique in under 2 hours! Available at www.thecostbenefitcoach.com
Cost Benefit Analysis - 10 Most Common Myths Debunked
There are many reasons why executives, business owners and others put off learning and implementing Cost Benefit Analysis in their businesses. Some of the reasons are listed below. You can gain the advantage over these by understanding the real truths of this powerful, decision-making tool.
Myth #1. It is only applicable to big business and government.
The common misconception is that Cost Benefit Analysis is only applicable to those companies or government departments that have a vast store of funds and have specialists to call on to pump out complex recommendations. Recommendations that relate to capital purchases and allocation of funds amongst competing projects or programs.
The truth is, that this method is equally applicable to small and large businesses or any size in between. It is really useful when any business or government is faced with having to make Capital Purchase decisions. For example:
Is it in the best interests of the company to invest in a new production line to boost output or to repair and maintain the current system?
Is this model PC a better investment than another PC? Do we really need to upgrade at all?
Or, is it in the best interests of the community to invest in safer school crossings, or apply the funds to environmental rehabilitation projects?
Myth #2. It is too complex for the layman to understand.
If you can read and understand this article and can do some basic math you can master Cost Benefit Analysis and apply it like a professional.
There are certain requirements that must be followed, but the actual process of working out the final answer, termed the Benefit Cost Ratio, is really quite straightforward. If you have a basic understanding of spreadsheets, that will make it even easier.
Myth #3. It will take too long to learn.
The beauty of this method is that it can be learnt in less than 2 hours. You only need to follow the rules and apply them. Once you have learnt the basics, then you can apply the method to simple or complex problems, small or large businesses, or low-cost to high-priced projects. You don’t need to learn new skills to apply it in different situations.
Myth #4. Easier ways give the same answers.
There are many ways used to come up with an answer to solve capital purchase and funds allocation questions. Some are OK and some are not so good. Since this proven and tested Cost Benefit Analysis method is used right around the world by governments and big business wouldn’t you be safer using the same method, built on the same principles?
The problem is that most times, these decisions can have a critical bearing on the success of the company – not to mention your reputation as well. The best answers can only be arrived at, by using the best method, and this is it.
Myth #5. Its only for accountants and managers.
Some would have you believe that this method is best undertaken by accountants and managers. Not true. Anyone with an average level of intelligence at any level in a business can use this well, if the rules are followed and applied.
Myth #6. It takes too long to assemble all the data.
This may well be true in some cases. Complex, high-cost problems that require a solid recommendation may need some time spent in collecting all the costs and benefits. However, when the correct answer is critical to the health of the business, sufficient time must be spent to get the RIGHT answer - not just AN answer.
You will find that once you have done a few of these, the costs and benefits will come to hand fairly easily and in a short period of time.
Myth #7. Its OK as a theory but it doesn’t really work in practice.
I have witnessed this working in many situations – from PC purchases to multi-million dollar asset replacement decisions. When it comes to capital purchase decisions – this is the best way to go.
Using this method has many advantages - a few are listed below:
- Compares competing projects quickly and accurately - saving time and effort.
- Quickly determines whether a project is VIABLE or UNVIABLE – easily cut out unviable options, thereby saving time and effort
- Decisions can withstand external scrutiny – saving worry and concern
- Allows accurate post-implementation review of original assumptions, so errors made in this project are not carried over to subsequent projects
Myth#8. It has only limited applicability.
Cost Benefit Analysis is best used in capital purchase situations, repair or replace decisions, and/or funding allocation choices. However, the method if used on these types of decisions is equally at home in large or small, complex or simple and low-cost to high-cost decisions.
Myth #9. It is too costly to implement.
The cost to implement this method across all sizes and complexity of decisions will be relative. Higher costs for high complexity decisions and the opposite is also true. Once the method has been used a few times the cost to apply it to these problems will reduce.
I know this to be true. I have seen it work and have been part of the process.
Myth #10. There are too few examples to learn from.
The Internet is full of examples. From the 1960s airports site decisions, to current events such as the allocation of funding (amount of funds to repair damage from Hurricane Katrina). Also there are numerous references to environmental decisions, allocation of government funds, sighting of school crossing traffic lights, cancer research, railway level crossing expenditure, new dam concerns and the list goes on and on.
In summary, Cost Benefit Analysis is easy to learn and is applicable across a wide range of topics and types of businesses. Take the time to learn how to apply it. Your career, your reputation and your prospects will definitely benefit.
Bruce Hokin is an experienced accountant (FCPA) specializing in Cost Benefit Analysis. You can find more of his in-depth FREE articles, FREE Newsletter and e-zines at his website. To sign up for his downloadable Cost Benefit Analysis training program "5 Steps to Cost Benefit Mastery" just go to his website. You could be using this technique in under 2 hours! Available at www.thecostbenefitcoach.com
Myth #1. It is only applicable to big business and government.
The common misconception is that Cost Benefit Analysis is only applicable to those companies or government departments that have a vast store of funds and have specialists to call on to pump out complex recommendations. Recommendations that relate to capital purchases and allocation of funds amongst competing projects or programs.
The truth is, that this method is equally applicable to small and large businesses or any size in between. It is really useful when any business or government is faced with having to make Capital Purchase decisions. For example:
Is it in the best interests of the company to invest in a new production line to boost output or to repair and maintain the current system?
Is this model PC a better investment than another PC? Do we really need to upgrade at all?
Or, is it in the best interests of the community to invest in safer school crossings, or apply the funds to environmental rehabilitation projects?
Myth #2. It is too complex for the layman to understand.
If you can read and understand this article and can do some basic math you can master Cost Benefit Analysis and apply it like a professional.
There are certain requirements that must be followed, but the actual process of working out the final answer, termed the Benefit Cost Ratio, is really quite straightforward. If you have a basic understanding of spreadsheets, that will make it even easier.
Myth #3. It will take too long to learn.
The beauty of this method is that it can be learnt in less than 2 hours. You only need to follow the rules and apply them. Once you have learnt the basics, then you can apply the method to simple or complex problems, small or large businesses, or low-cost to high-priced projects. You don’t need to learn new skills to apply it in different situations.
Myth #4. Easier ways give the same answers.
There are many ways used to come up with an answer to solve capital purchase and funds allocation questions. Some are OK and some are not so good. Since this proven and tested Cost Benefit Analysis method is used right around the world by governments and big business wouldn’t you be safer using the same method, built on the same principles?
The problem is that most times, these decisions can have a critical bearing on the success of the company – not to mention your reputation as well. The best answers can only be arrived at, by using the best method, and this is it.
Myth #5. Its only for accountants and managers.
Some would have you believe that this method is best undertaken by accountants and managers. Not true. Anyone with an average level of intelligence at any level in a business can use this well, if the rules are followed and applied.
Myth #6. It takes too long to assemble all the data.
This may well be true in some cases. Complex, high-cost problems that require a solid recommendation may need some time spent in collecting all the costs and benefits. However, when the correct answer is critical to the health of the business, sufficient time must be spent to get the RIGHT answer - not just AN answer.
You will find that once you have done a few of these, the costs and benefits will come to hand fairly easily and in a short period of time.
Myth #7. Its OK as a theory but it doesn’t really work in practice.
I have witnessed this working in many situations – from PC purchases to multi-million dollar asset replacement decisions. When it comes to capital purchase decisions – this is the best way to go.
Using this method has many advantages - a few are listed below:
- Compares competing projects quickly and accurately - saving time and effort.
- Quickly determines whether a project is VIABLE or UNVIABLE – easily cut out unviable options, thereby saving time and effort
- Decisions can withstand external scrutiny – saving worry and concern
- Allows accurate post-implementation review of original assumptions, so errors made in this project are not carried over to subsequent projects
Myth#8. It has only limited applicability.
Cost Benefit Analysis is best used in capital purchase situations, repair or replace decisions, and/or funding allocation choices. However, the method if used on these types of decisions is equally at home in large or small, complex or simple and low-cost to high-cost decisions.
Myth #9. It is too costly to implement.
The cost to implement this method across all sizes and complexity of decisions will be relative. Higher costs for high complexity decisions and the opposite is also true. Once the method has been used a few times the cost to apply it to these problems will reduce.
I know this to be true. I have seen it work and have been part of the process.
Myth #10. There are too few examples to learn from.
The Internet is full of examples. From the 1960s airports site decisions, to current events such as the allocation of funding (amount of funds to repair damage from Hurricane Katrina). Also there are numerous references to environmental decisions, allocation of government funds, sighting of school crossing traffic lights, cancer research, railway level crossing expenditure, new dam concerns and the list goes on and on.
In summary, Cost Benefit Analysis is easy to learn and is applicable across a wide range of topics and types of businesses. Take the time to learn how to apply it. Your career, your reputation and your prospects will definitely benefit.
Bruce Hokin is an experienced accountant (FCPA) specializing in Cost Benefit Analysis. You can find more of his in-depth FREE articles, FREE Newsletter and e-zines at his website. To sign up for his downloadable Cost Benefit Analysis training program "5 Steps to Cost Benefit Mastery" just go to his website. You could be using this technique in under 2 hours! Available at www.thecostbenefitcoach.com
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