Project Management guide · Cost and resources
Cost-Benefit Analysis for Projects: Steps and Example
Cost-benefit analysis (CBA) compares the total expected costs of a project with its total expected benefits to decide whether it is worth doing, or which of several options is best. Good CBAs put money values on costs and benefits over time and discount future amounts to today's value.
Key takeaways
- CBA compares all costs and benefits in money terms.
- Discount future amounts and include a do-nothing option.
- NPV above zero and BCR above 1 suggest a worthwhile project.
- Test key assumptions with sensitivity analysis.
When to use cost-benefit analysis
- Building a business case or feasibility study.
- Choosing between alternative solutions or suppliers.
- Deciding whether to approve a major change request.
- Prioritising projects in a portfolio.
Costs and benefits to include
| Costs | Benefits |
|---|---|
| Initial investment: labour, hardware, software, fees | Extra revenue |
| Running costs: support, licences, maintenance | Cost savings |
| Training and change management | Avoided costs, such as fines or downtime |
| Disruption during the change | Faster delivery or better quality |
| Decommissioning | Intangibles: satisfaction, reputation, morale |
How to do a cost-benefit analysis
- Define the decision and the options, including doing nothing.
- List all costs and benefits for each option over an agreed period.
- Put a money value on each, and note intangibles separately.
- Discount future amounts using an agreed discount rate; see net present value.
- Calculate net benefit (PV benefits - PV costs) and the benefit-cost ratio (PV benefits / PV costs).
- Test key assumptions with sensitivity analysis.
- Recommend an option, stating assumptions and risks.
Worked example
A new booking system costs $120,000 up front plus $10,000 a year to run. It saves $60,000 a year. The analysis uses three years and an 8% discount rate (three-year annuity factor 2.5771).
| Undiscounted | Present value | |
|---|---|---|
| Costs | 120,000 + 3 x 10,000 = $150,000 | 120,000 + 10,000 x 2.5771 = $145,771 |
| Benefits | 3 x 60,000 = $180,000 | 60,000 x 2.5771 = $154,626 |
| Net benefit (NPV) | $30,000 | $8,855 |
| Benefit-cost ratio | 1.20 | 154,626 / 145,771 = 1.06 |
The project is worthwhile because the BCR is above 1 and NPV is positive, but the margin after discounting is thin, so a sensitivity test on the savings estimate is essential.
Decision rules
| Measure | Accept if |
|---|---|
| Net present value | Greater than zero |
| Benefit-cost ratio | Greater than 1 |
| Return on investment | Above the organisation's target |
| Payback period | Shorter than the maximum allowed |
Common pitfalls
- Counting benefits that would happen anyway.
- Leaving out running, training or disruption costs.
- Ignoring the time value of money over multi-year periods.
- Double-counting the same benefit under different names.
- Presenting a single number without testing the assumptions.
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Frequently asked questions
What is a cost-benefit analysis?
A comparison of a project's total expected costs with its total expected benefits, in money terms, to decide whether it is worthwhile.
What is the benefit-cost ratio in a cost-benefit analysis?
Present value of benefits divided by present value of costs. A ratio above 1 means benefits exceed costs.
How do you calculate net benefit in a cost-benefit analysis?
Net benefit = total benefits - total costs, ideally using present values, which gives the NPV.
Why discount future costs and benefits in a cost-benefit analysis?
Money received in the future is worth less than money today, so discounting makes amounts at different times comparable.
What discount rate should I use in a cost-benefit analysis?
Usually the rate set by your finance team, often based on the organisation's cost of capital or a required rate of return.
How do you handle intangible benefits in a cost-benefit analysis?
Estimate a money value where reasonable, otherwise list them separately and describe them clearly alongside the figures.
What is the difference between cost-benefit analysis and ROI?
CBA weighs all costs and benefits, often as NPV or BCR. ROI expresses net gain as a percentage of cost.
Should a cost-benefit analysis include a do-nothing option?
Yes. It gives a baseline, and doing nothing often has its own costs.
Who prepares a cost-benefit analysis?
Often the project manager or business analyst with finance, for review by the sponsor.
Where does CBA fit in a project?
In the business case and feasibility stage, and again when major changes are considered.
What are the limitations of cost-benefit analysis?
It depends heavily on estimates of future benefits, which can be uncertain or optimistic.