Cost-benefit analysis means analyzing and evaluating ‘costs’ and ‘benefits’ before taking a particular decision. By comparing costs with the benefits, it becomes easier to make a decision.
This technique is frequently used in making critical decisions like the expansion of business, entry into a new market, replacement of an old machine, and so on.
We will explain the whole content below but you can get more knowledge about Analysis In Decision Making on the finance program on Rainiertamayo. So let’s understand how Cost-Benefit Analysis can be used with the help of an example:
A sole proprietor is having problems in monitoring accounts receivables. As a result of which, he is not able to recover the dues on time. To deal with this problem, he consults his friend who is an accounts receivables manager in a reputed concern. His friend advises him to buy an automated accounts receivable solution. Before investing in the product, the proprietor decides to do a cost-benefit analysis.
He considers the advantages that he is going to get in terms of easy monitoring, quick collection and reduced accounts receivables balance, better handling of customer issues, less manual interference and so on. While considering the cost factor, he takes into account the expected payback period, current capital availability, implementation process in terms of time and complexity, costs of training staff on the new system and so on.
After doing this analysis, the proprietor decides that the costs associated with maintaining receivables are far greater than the cost of acquiring and implementing the automated solution. He thinks that since there will be a quick turnover of receivables with this system; he will be able to utilize funds for expansion of his business and also improve upon his sales.
Above mentioned illustration indicates a business situation. Cost-benefit analysis can also be performed at an individual level.
Let us take an example of how an individual can use this technique for making a decision.
You decide to replace your desktop computer with a new laptop. You might associate the following benefits with a laptop:
a) Improved technology.
b) Less space requirement.
c) Portability. You can carry your laptop at important meetings; do project work, surf the internet on the move and so on.
d) Faster communication. You don’t have to worry about reaching home to reply to important emails.
e) Limited problem due to power supply disconnection. You can work continuously for two to three hours even when there is no electricity.
Now you evaluate the cost based on:
a) Capital required for buying the laptop. You can also base your decision on whether the installment facility is available or not.
b) Cost of maintenance. You can take annual maintenance or decide to get it repaired as and when the need arises.
Cost-benefit analysis can help in taking quick decisions. To have a proper cost-benefit analysis, it becomes important to quantify the costs and benefits, otherwise, it may become difficult to make an appropriate comparison. Some benefits and costs do not occur immediately but may occur shortly. Hence, it becomes important to use the concept of the time value of money to arrive at the present value of all current as well as future benefits and costs.
