What is a cost-benefit analysis (CBA)?

Understanding cost-benefit analysis

Cost-benefit analysis compares a project or decision's estimated or projected costs and benefits. It’s a vital component of project management because it measures a project’s financial feasibility and helps companies avoid losses. If the analysis shows that the benefits outweigh the costs, you can assume that the project will be profitable for your company and that it’s viable to proceed.

In contrast, if the costs exceed the expected benefits, the project is not viable and should be rejected.

You can use cost-benefit analysis in the following scenarios:

• Project initiation: CBA allows you to forecast the viability of your project by comparing the potential benefits and costs. You can decide whether to proceed or decline based on the expected value.
• Budgeting: You can manage multiple projects more efficiently with a limited budget. By evaluating the anticipated benefits, CBA will tell you whether to approve your allocated budget. 
• Resource allocation: You can effortlessly calculate the ROI (Return on investment) and thus identify which projects will be more lucrative. CBA can optimize your resource allocation and distribute them more efficiently, especially when integrated with project scheduling software. 
• Risk management: Using CBA, you can assess risks and apply mitigation strategies, leveraging Scrum to address risks iteratively and adaptively. It also enables you to allocate a budget for potential risks based on the cost-benefit trade-offs of different contingency measures.
• Improving communication: Evaluating CBA, especially when visualized through a Kanban Board, can help justify your project decisions and enhance transparency with a quantitative approach, improving stakeholder communication.

• Policy development: CBA can guide you in evaluating new policies or regulations within the project framework to apply implementation strategies. You can ensure regulatory compliance by assessing the costs and benefits of different compliance approaches. 

Using cost-benefit analysis, you can make informed decisions that evaluate your project discovery, align with your organizational goals, optimize resource use, and maximize project value.

Due to its data-driven nature, CBA can also be applied to product analytics, product development strategy, and other economic decisions. Whether using Agile or Waterfall methodology to manage your projects, CBA is crucial.

Advantages of using CBA in project management

Decision-makers need information to make crucial decisions, making CBA a helpful tool for project management. For example, if you constantly want to evaluate your project and make decisions to ensure a smooth and dynamic analysis, use lean methodology to avoid chaos.

Cost-benefit analysis can help you with the following aspects of project planning:

• Objective decision-making. Objective decision-making is a data-driven approach in which analysts collect and analyze data to help make decisions. This approach is fully evidence-based and free from biases, allowing for more informed decisions. Remember, CBA is a useful tool for collecting relevant data.
• Risk mitigation. CBA helps the project management team identify potential issues such as budget overruns, scope creep, resource allocation problems, risk management challenges, stakeholder conflicts, regulatory compliance issues, technological difficulties, quality assurance problems, market changes, environmental and social impacts, and communication breakdowns. Alternatively, if the project seems unprofitable, the company can drop it to avoid the risk of losses.
• Resource optimization. CBA helps you identify hidden costs associated with a project. This information provides the tools you need to generate alternate options for resource allocation and optimize resources to minimize costs and maximize benefits. 
• Stakeholder confidence. CBA increases the chance of project success because the team will only select profitable projects. Successful projects help companies gain stakeholder confidence.

Challenges and limitations of CBA

Although CBA is crucial for the decision-making process in project management, it’s not free from limitations. 

Determining the monetary value of intangible costs and benefits can be challenging as they rely heavily on assumptions. As a result, you may not get a clear picture of the effect of these components. Initially, a project may seem profitable, but intangible losses underestimated during the CBA process can lead to unexpected future losses.

Moreover, if you’re working with limited cost and benefit data, the result will not be accurate. These factors can influence the analysis's results and lead to false predictions.

How to conduct a cost-benefit analysis for project management

Follow these steps to conduct an accurate cost-benefit analysis for your next project:

Define the project scope

The first step in cost-benefit analysis is defining the project scope and creating a framework. A simple project plan template makes this easy. You can start by stating the purpose of the analysis. Similarly, you should define your goals and objectives.

Determine the required resources, equipment, timeline, evaluation technique, personnel requirements, and relevant data. At this stage, you should also identify and notify key stakeholders so they can provide their input.

To simplify the process, use a common currency for all monetary values. Remember, this is teamwork, and you should apply proper team management strategies to achieve the best outcome.

Identify costs and benefits

The second step is to identify all the related costs and benefits. Sit down with your project management team and hold a brainstorming session to ensure you cover all the bases -- a brainstorming template can help keep the conversation productive. This is where you may find hidden costs that were not apparent at first glance. 

Once you identify the project’s costs and benefits, you should start categorizing them as direct, indirect, tangible, intangible, and others. Note that you only identify the items in this step, not their monetary values.

Assign monetary values

When you finish categorizing all the cost and benefit items, it’s time to assign them a monetary value. 

Quantifying tangible costs and benefits using market prices, historical data, and estimation techniques should be easy, but quantifying intangible items can be difficult.

However, you can try the contingent valuation method (CVM), hedonic pricing method, cost-effectiveness Analysis (CEA), or software to get closer to an accurate estimation and assign dollar value more efficiently.

Calculate net present value (NPV)

The cost-benefit analysis includes many future cash inflows and outflows. Calculating their current worth is essential to understanding their current worth. 

Then, you can find the difference between the costs and benefits to calculate the NPV, which indicates whether the project will be profitable.

The calculations include four factors: benefits (B), costs (C), interest rate or discount rate (i), and the number of years since starting the project (t).

Below is the formula for calculating net present value:

NPV = B₀-C₀(1+i)₀+B₁-C₁(1+i)₁+......+B_t-C_t(1+i)_t,

Or, NPV = \[\sum_{t=0}^T\Bigg\{{(B_t- C_t) \over (1+i)^t}\Bigg\}\Bigg\{(B_t- C_t) / (1+i)^t\]  

Where:

• NPV is the present value. 
• t is the time period (starting from 0 up to T).
• Bt is the cash inflow at time t. 
• C_t is the cash outflow at time t. 
• i is the discount rate or the interest rate.  

The formula uses a chosen discount rate to find the present value of all the future costs and benefits. As discussed earlier, different methods can be used to select a discount rate for the analysis. Finding the present value of all the future cash flows sums up the differences between the costs and benefits to find the NPV.

Here is the simpler formula:

Net present value (NPV) = Present value of future benefits - Present value of future costs

Analyze your results

The NPV tells you whether the project will be profitable. You’ll likely get one of the three results: 

• Positive: A positive value means the project will be profitable, and you can accept it. 
• Negative: A negative value means it will be unprofitable, and you should ditch the project. 

• Zero: A zero value means you’ll neither profit nor lose money from it.

Make informed decisions

Depending on the results of the analysis, you will need to make a decision. Meet with your project management team and decide whether to proceed or halt the project.

Make smarter decisions with cost-benefit analysis in Confluence

Cost-benefit analysis is imperative to make informed decisions and manage risks. Despite a few limitations, it’s an excellent method to determine if a project or economic activity is profitable. Following this guide, you can properly conduct your cost-benefit analysis to manage projects more efficiently.

It’s crucial to share the cost-benefit analysis report, project updates, and business decisions with your team members to ensure everyone is on the same page. Again, performing the analysis manually can be difficult and time-consuming. To address these issues, we recommend using project collaboration software like Confluence. 

Confluence allows you to conduct a cost-and-benefit analysis and communicate all project updates in real-time with your teammates. It enables you to do the job your way: take notes, brainstorm on a whiteboard or record videos. You can invite your peers to collaborate through real-time editing and inline comments. When you’re ready, you can easily share with your broader company. 

Its intuitive navigation and powerful search ensure your work stays organized and connected to the right teams, projects, and goals, even as your business scales and grows. Key company-wide and project-related knowledge is centralized in one place, making it instantly accessible and ready to move your business forward.

Try Confluence for free

What is a cost-benefit analysis?

A cost-benefit analysis is a company's systematic approach to evaluating the strengths and weaknesses of a project, business, or any economic activity related to decision-making.

What are the five steps of cost-benefit analysis?

The five steps of cost-benefit analysis are: 1) Identifying costs and benefits, 2) Quantifying costs and benefits, 3) Calculating net present value, 4) Assessing risk and uncertainty, and 5) Making a decision.

What is a cost-benefit analysis example?

Examples of cost-benefit analysis include assessing the expenses of manufacturing a product, conducting a project budget review, and comparing the costs of different healthcare treatments.