Learn what a cost-benefit analysis is, why it’s important, and its pros and cons. We’ve also got an example of how to create your own.
As a freelancer or a business owner working from home, you've likely been presented with a project and have wondered, "How do I know if this will work?" Taking on a project and spending money on resources is a big gamble if you still need to research to determine its viability. Enter cost-benefit analysis: a powerful tool designed to assess the pros and cons of potential projects and decisions.
In this guide, we'll cover the definition of cost-benefit analyses and when to use them, and we’ll also provide a template you can use to create your own.
What is a cost-benefit analysis, and why is it important? 🤔
A cost-benefit analysis –– also called a CBA, benefit-cost analysis, or opportunity-cost analysis –– is a decision-making tool to determine the overall value of an action for a business, whether a strategy, a project, or even personal decision-making. Specifically, it involves weighing the total expected costs against the expected benefits of one or more actions to choose the best or most profitable option. The main purpose of a CBA is to simplify complex business decisions by quantifying the potential risks and rewards.
A CBA’s importance lies in its ability to provide a clearer picture of potential financial, social, and operational outcomes, helping businesses, governments, and individuals make informed decisions that can optimize the value of their investments and actions.
When to do a cost-benefit analysis ⌚
As mentioned, a cost-benefit analysis works best when determining an action's pros and cons. While you can use it for less concrete things, in the business world, it’s often used for actions with concrete evidence to back up advantages or disadvantages.
For example, you could use a CBA when:
- Determining a project’s profit or feasibility compared to the cons (in other words, the return on investment or ROI)
- Deciding where to allocate resources based on what would yield more benefits, like a new marketing campaign or investing in training your employees
- Debating how changing a specific policy will impact the workplace environment, employee performance, and employee satisfaction
How to do a cost-benefit analysis in 5 steps 🪜
Every business decision, big or small, comes with its own set of risks and rewards. And to make informed choices, integrating a cost-benefit analysis into your business requirements document is pivotal before starting a project or creating a project roadmap. Here are five steps to create a cost-benefit analysis:
1. Establish a framework 🖼️
Start by providing context to your current situation (current performance, improvement areas, time frame, etc). Next, list what you hope to achieve (gain more website visitors) with the actions you want to take (perform a content marketing campaign), and provide metrics you'll use (website traffic) to measure the advantages and disadvantages.
2. Determine potential costs and benefits 💰
Next, outline all the expected costs and benefits you can think of using a cost-benefit ratio. This stage is up in the air, so to speak; you don't have to be too rigid in your thinking. The types of costs associated with a CBA are usually:
- Direct costs
- Indirect costs
- Intangible costs
- Costs of potential risks
And benefits include:
- Direct benefits: These are typically ROIs, like more people buying products from the website if the content marketing plan is successful. This is important for calculating the net present value.
- Indirect benefits: These are unquantifiable benefits, like increased brand awareness or authority within your niche.
3. Expand on costs and benefits 🥳
Once you list all the possible costs and benefits of your proposed course of action, expand on them. Start by assigning the advantages and disadvantages into categories like the ones mentioned above. Then, give them quantifiable values, like dollar amounts or performance percentages. This is the most vital step as it's necessary for analyzing and making a recommendation.
4. Analyze costs and benefits 🤑
Now that you have approximate values assigned to each cost and benefit, analyze them. This process involves weighing the pros and cons and comparing it to your created framework. Be sure to compare the costs and benefits in proportion. For example, you may have five costs/cons, but the only benefit may have far more value. Conversely, you may have far more benefits than drawbacks, but a singular cost may be too great.
5. Make a recommendation 🌟
The final step is to make a recommendation once you have an idea of your action's overall impact. A simple way to do this is to think about:
- Is the net cost-benefit positive? If so, go ahead with your action; still, consider if there are alternative approaches to increase the benefit, especially if it's small.
- Is the net cost-benefit negative? If yes, it might not be worth it since the costs outweigh the benefits. There might be other approaches to reduce the costs, though.
- Do your key performance indicators (KPIs) support your action? Although you might have more benefits than costs, if the real-world application of your effort doesn't have long-term success, it may not be worth it.
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Pros and cons of a cost-benefit analysis 🎭
A cost-benefit analysis might seem like an additional layer of work, but its merits and pitfalls can influence business outcomes significantly. Here are a few advantages and disadvantages of employing a CBA to guide your business decisions:
- Improved risk mitigation: Business owners and project managers can foresee potential risks and develop strategies to counteract them by identifying potential costs and benefits, ensuring smoother project execution.
- Informed decision-making: CBAs provide a clear picture of potential ROIs, helping make intelligent choices about project feasibility and resource allocation.
- Clear intangible costs: While some benefits or costs may not have a direct monetary value, CBAs help place a tangible or semi-tangible value on them, assisting in evaluating factors like brand value, customer satisfaction, or potential long-term gains.
- Time-consuming: Conducting a thorough CBA can be a lengthy process. For freelance analysts with time constraints or businesses on tight schedules, this can pose challenges.
- Potential for bias: A CBA’s results are as good as input data. Biased or incorrect data can lead to skewed results, potentially leading business owners and project managers down an undesired path.
- Doesn't account for all variables: While CBAs can provide insights into many factors, they might not capture every potential outcome or external factors, such as sudden market changes or unforeseen global events.
Cost-benefit analysis example 🧾
To see how a simplified cost-benefit analysis works in action using the steps above, here’s an example:
Situation: Your website has been receiving fewer visitors, and the goal is to gain more traffic.
- Establish a framework: Perform a content marketing campaign, and use visitor metrics to measure success.
- Determine potential costs and benefits: Your direct costs would be hiring content creators and photographers, paying for stock photos, and providing content creation software. Your indirect costs might be increased electricity consumption. And your benefits would be increased website traffic and increased brand awareness.
- Expand on costs and benefits: Hiring content creators costs $5,000, licensing the software costs $2,000, and electrical costs amount to $200. You could anticipate the sales to increase by $20,000 over the first two months.
- Analyze costs and benefits: This is where you compare everything.
- Make a recommendation: You might conclude the net result is positive, with the projected income outweighing the costs. You might also consider an approach to make content more evergreen so the anticipated period for increased sales is longer.
Put your skills to use with Contra 🔧
Decision-making, without much data, can often feel daunting. But tools like cost-benefit analysis provide a structured way to assess the feasibility and potential return of projects, both for your own endeavors and those of your clients. Independents looking to evaluate project viability meticulously can follow Contra to ensure well-informed decisions every time.
And if you're a client in search of expertise to help implement strategic projects, Contra is your go-to platform. Here, you can match with top-tier freelancers, ensuring that every step of your business journey is backed by the best talent.