The 10 Most Asked Questions Of Cost Benefit Analysis

The 10 Most Asked Questions Of Cost Benefit Analysis

The 10 Most Asked Questions of​ Cost Benefit Analysis
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.
Lets 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​ decisionmaking 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 decisionmaking 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​ oncosts.
Question​ #4. How do I ​ treat nonfinancial costs and​ benefits?
Since only cash transactions both costs and​ benefits are included in​ Cost Benefit models, nonfinancial costs and​ benefits are usually described by way of​ notes.
if​ the Benefit Cost Ratio is​ = to​ 1 or​ > 1 then the use of​ nonfinancial costs and​ benefits would not be required since the project is​ already VIABLE. Normally these nonfinancial 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 reassign 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 projects 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 decisionmakers 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 underemployed.

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.

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