How to Do a Project Management Cost-Benefit Analysis
Before embarking on a journey that is executing a project, you have to know if it’s worth it.
In life, you make a mental list.
As a project manager, you perform a cost-benefit analysis.
In this article, we’re going to show you how to perform and evaluate a cost-benefit analysis so you’re 100% certain that your next project will be successful.
Let’s take a look!
What Is Cost-Benefit Analysis?
According to the official definition, cost-benefit analysis (CBA) is a business process that adds up all the benefits of an initiative (i.e. a project) and then subtracts the associated costs.
So, for example, the benefits of your project could be $1 million in terms of revenue, and your costs could be $500k.
The benefits would outweigh the costs, giving you a firm green go-ahead light
If that’s the case, then your project is financially feasible.
But if you’d earn $1 million in revenue, and your costs would be $2 million, then the initiative wouldn’t be feasible.
|Option A||Option B||Option C|
The Importance of Cost-Benefit Analysis in Project Management
Who invests in for-profit projects without getting an estimate of their Return on Investment (ROI)?
Very few people.
And as an unbiased method of assessing benefits, costs, and profits, CBA is an excellent way to evaluate the feasibility of your project.
When your project is objectively proven as feasible and profitable, you will:
- Get stakeholder support
- Attain the green light from top management
- Easily evaluate and control your project’s progress.
Conversely, if you don’t run a CBA, you’ll have to talk your stakeholders into working on the project.
After all, they have no proof that the project is going to be successful in the long term.
You’ll have to constantly prove that you’re minimizing costs and maximizing benefits.
It’s a lot of stress. And guesswork isn’t a project management method.
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The Process of Cost-Benefit Analysis in Project Management
Cost-Benefit Analysis dates back to the 18th century when a French engineer and economist by the name of Jules Dupuit decided to evaluate the feasibility of a construction project by taking a look at how much people were willing to pay for it.
The process hasn’t changed much to this day.
We still express the value of projects and initiatives in terms of monetary value. It’s a common unit of measurement.
So let’s start off simple. Your first step is to…
1. List All the Costs and the Benefits of Your Project
Grab a sheet of paper and jot down all the costs and benefits associated with your project.
But before you dig in, keep in mind that there is such a thing as (lost) opportunity cost.
When you choose one option, you’re shouldering the cost of benefits lost by not choosing other options (i.e. opportunities).
For example, by taking the highway (and enjoying the benefits of a faster arrival time), you’re losing the opportunity to take the train (and minimize gas and toll costs).
So when you’re running a cost-benefit analysis for one option, consider other options, as well as their costs and benefits.
Just make sure that all the options are fulfilling the goal you’ve set out to achieve.
The most common benefits are:
- Revenue from sales
- Improved customer satisfaction
- Higher staff morale
- Competitive advantage
- Increased market share.
And so on.
Again, your benefits don’t have to be fiscal.
But the truth is, you can measure intangible benefits such as improved customer satisfaction with money, as well. If customers are happy, they’ll buy more.
Calculating the costs and benefits of adding Italian food to the menu Source: SixSigma
- Common costs include:
- Workforce (the cost of labor)
- Inventory/manufacturing expenses
- Overhead expenses (e.g. electricity)
- Potential risks (e.g. regulatory risks)
- Customer impact
- Lost opportunity costs
- Long-term maintenance costs.
You should consider long-term costs, as well, not just immediate costs.
For example, if you’re evaluating the feasibility of migrating the entire company to new software, you have to factor in the software’s costs in the long term, too.
Perhaps even training, if necessary.
When conducting a CBA, it’s important to be thorough.
One of the most popular techniques for estimating project time and cost is certainly the Work Breakdown Structure (WBS).
WBS breaks down your project work into manageable bits.
From there, you can calculate the cost of labor, materials, and much more for each task.
After finishing the CBA, you can always reassess certain items without jeopardizing the future of the project.
2. Add Up the Figures.
Once you’ve listed your costs and benefits, it’s time to add it all up.
Finding the right numbers can be hard sometimes, so it’s best to look at market benchmarks and historical data.
However, don’t focus on your historical data too much if it’s old or different.
Always keep both feet on the ground with current market data.
But if you’re using historical data, make sure you convert it to the current value (adjust the past numbers for inflation and current value).
The more accurate your estimates are, the more accurate will your CBA be!
For the simplest equation, simply compare the sum of your costs column to the sum of your benefits column.
If your benefits outweigh the costs, you likely have a winner.
3. Evaluating Your Cost-Benefit Analysis in Project Management
If you want to make sure your cost-benefit analysis is 100% sound, you should also calculate the ROI (Return on Investment):
Total cost/total revenue (benefits) = Length of time (payback period)
Additionally, you can also factor in the discount rate (Will people be more willing to pay for the benefits in the future, and how much?) and Net Present Value (What are the immediate benefits and costs?).
You should also run a sensitivity analysis.
Sensitivity analysis (also called the “What-If Analysis”) considers risks and uncertainties in your projections.
You could also consider worst-case scenarios.
For example, how would your figures change if your sales were only 30% of the sales you predicted in your estimates?
Would that impair the project’s feasibility?
Using Cost-Benefit Analysis in Project Management
Some project managers like evaluating the subjective effects of the project:
- How will the project affect users?
- Will it affect the general public?
- How will the project affect the company?
This is really beneficial if your project has a social connotation to it.
For example, if the project is meant to improve the company’s approach to renewable resources, then it’s worth sacrificing some benefits just to implement it, and generate more value in the long term.
Similarly, if your discount rate analysis shows that the interest for your project’s product will grow in time, then it’s still beneficial – even if the payback period is longer.
Ultimately, it all depends on your company’s strategic goals.
But if your project plans on achieving short or long-term goals while keeping the costs to a minimum, there’s no reason for it not to be successful.
It’s time to ace your CBA!