Cost

Analysis

Bishwajit Mazumder
Nursing Instructor
Dhaka Nursing College, Dhaka
E. mail: [email protected]

Introduction
Cost analysis is the break up/classification of the aggregate costs into
relevant types. Such an analysis of cost is an essential pre-requisite of controlling
costs as well as of decision making. Identifiability of cost (direct cost) with units of
products of operations is one such basis of cost classification. The importance of
distinguishing costs as direct or indirect lies in the fact that direct costs of a product or
an activity can be accurately allocated while indirect costs have to be apportioned on
the basis of certain assumptions. Thus it is helpful for management if costs are
classified on the basis of their identifiability with the units of products, processes or
work orders. This is so because direct costs are controllable at the operational level
whereas indirect costs are not amenable to such control. For the purpose of decision
making and control, costs are distinguished on the basis of their relevance to the
different types of decisions and control functions. Thus, expenditure which has taken
place, is irrecoverable in a situation, is regarded as sunk cost.
Cost incurred as a result of past decisions which cannot be altered by
another decision at a subsequent date is known as sunk cost. Thus, for decisions with
future implications, a sunk cost is an irrelevant cost. If a decision has to be made
whether to replace the existing plant, the book value of the existing plant is to be
regarded as a sunk cost as it is irrelevant to the question of its replacement. The
decisive factor would be the difference in income which will result from the
installation of a new plant, and the expected rate of return on the new investment.
Costs which are relevant are only to be taken into account and all such costs are
analyzed accordingly. Present and future cash expenditure connected with a decision
is the result of proper cost analysis.
Costs can be classified according to their nature and information needs of the
management in the following manner:

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Analysis

i.

By element : Under this classification costs are classified into (a) Direct costs and
(b) Indirect costs according to elements viz., materials, labour and expenses.

ii.

By function : Hence costs are classified as : production cost; administration cost;

selling costs; distribution cost; research cost; development cost, etc.

iii.

By behavior :According to this classification costs are classified as fixed; variable

and semi variable costs. Fixed costs can be further classified as committed and
discretionary.

iv.

By controllability :

Costs are classified as controllable and non-controllable

costs.
v.

By normality :

Under this classification costs are segregated as normal and

abnormal costs.
Management of a business house requires cost information for decision making under
different circumstances. For example they required such information for fixing selling price,
controlling and reducing costs. To perform all these functions a classification of cost
according to their nature and information needs is an essential pre-requisite of the
management.

What is cost?
Cost is an amount that has to be paid or given up in order to get something. In
business, cost is usually a monetary valuation of (1) effort, (2) material, (3) resources,
(4) time and utilities consumed, (5) risks incurred, and (6) opportunity forgone in
production and delivery of a good or service. All expenses are costs, but not all costs
(such as those incurred in acquisition of an income-generating asset) are expenses.

What is cost management?

Cost management is the process of planning and controlling the budget of a
business. Cost management is a form of management accounting that allows a
business to predict impending expenditures to help reduce the chance of going over
budget.

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Analysis

Many businesses employ cost management plans for specific projects, as

well as for the over-all business model. When applying it to a project, expected costs
are calculated while the project is still in the planning period and are approved
beforehand. During the project, all expenses are recorded and monitored to make sure
they stay in line with the cost management plan. After the project is finished, the
predicted costs and actual costs can be compared and analyzed, helping future cost
management predictions and budgets.
Implementing a cost management structure for projects can help a business
keep their over-all budget under control. Several business intelligence (BI) programs,
such as Oracle Hyperion, offer cost management software to help businesses monitor
costs and increase profitability. While the software may help, it is not imperative that
software is used when executing a cost management plan. Vendors may refer to cost
management software applications as cost accounting, spend management or cost
transparency products.
What is cost accounting?
Cost accounting involves the techniques for:
1. determining the costs of products, processes, projects, etc. in order to report the
correct amounts on the financial statements, and
2. assisting management in making decisions and in the planning and control of an
organization.
For example, cost accounting is used to compute the unit cost of a
manufacturers products in order to report the cost of inventory on its balance sheet
and the cost of goods sold on its income statement. This is achieved with techniques
such as the allocation of manufacturing overhead costs and through the use of process
costing, operations costing, and job-order costing systems. Cost accounting assists
management by providing analysis of cost behavior, cost-volume-profit relationships,
operational and capital budgeting, standard costing, variance analyses for costs and
revenues, transfer pricing, activity-based costing, and more.

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Analysis

Cost accounting had its roots in manufacturing businesses, but today it

extends to service businesses. For example, a bank will use cost accounting to
determine the cost of processing a customers check and/or a deposit. This in turn may
provide management with guidance in the pricing of these services.

Definition of cost breakdown

Cost breakdown is the systematic process of identifying the individual
elements that comprise the total cost of a good, service or package. It assigns a
specific dollar value to each element. Alternately, the value of the individual elements
is expressed as a percentage of the total cost. For instance, if you visited your
mechanic and got a $100 bill, $25 or 25 percent might be the cost of parts, while the
remaining $75 or 75 percent of the bill might be labor. If the price of a good, service
or package is significantly higher than the breakdown, the company may be charging
exorbitantly. If the price is significantly lower than the breakdown, the company
likely is taking a loss for working with the client.

What is cost analysis?

Cost analysis (also called economic evaluation, cost allocation, efficiency
assessment, cost-benefit analysis, or cost-effectiveness analysis by different authors)
is currently a somewhat controversial set of methods in program evaluation. One
reason for the controversy is that these terms cover a wide range of methods, but are
often used interchangeably.
At the most basic level, cost allocation is simply part of good program
budgeting and accounting practices, which allow managers to determine the true cost
of providing a given unit of service (Kettner, Moroney, & Martin, 1990). At the most
ambitious level, well-publicized cost-benefit studies of early intervention programs
have claimed to show substantial long-term social gains for participants and cost
savings for the public (Berreuta-Clement, Schweinhart, Barnett, et al., 1984). Because

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Analysis

these studies have been widely cited and credited with convincing legislators to
increase their support for early childhood programs, some practitioners advocate
making more use of cost-benefit analysis in evaluating social programs (Barnett,
1988, 1993).
Others have cautioned that good cost-benefit or cost-effectiveness studies
are complex, require very sophisticated technical skills and training in methodology
and in principles of economics, and should not be undertaken lightly (White, 1988).
Whatever position you take in this controversy, it is a good idea for program
evaluators to have some understanding of the concepts involved, because the cost and
effort involved in producing change is a concern in most impact evaluations (Rossi &
Freeman, 1993).

Cost allocation
Cost allocation is a simpler concept than either cost-benefit analysis or costeffectiveness analysis. At the program or agency level, it basically means setting up
budgeting and accounting systems in a way that allows program managers to
determine a unit cost or cost per unit of service. This information is primarily a
management tool. However, if the units measured are also outcomes of interest to
evaluators, cost allocation provides some of the basic information needed to conduct
more ambitious cost analyses such as cost-benefit analysis or cost-effectiveness
analysis. For example, for evaluation purposes, you might want to know the average
cost per child of providing an after-school tutoring program, including the costs of
staff salaries, snacks, and other overhead costs. Besides, budget information, being
able to determine unit costs means that you need to be collecting the right kind of
information about clients and outcomes. In many agencies, the information recorded
in service records is based on reporting requirements, which are not always in a form
that is useful for evaluation. If staff in a prenatal clinic simply reports the number of
clients served by gender, for example, you might know only that 157 females were
served in March. For an evaluation, however, you might want to be able to break
down that number in different ways.

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Analysis

For example, do young first-time mothers usually require more visits than
older women? Do single mothers or women with several children miss more
appointments? Is transportation to appointments more of a problem for women who
live in rural areas? Are any client characteristics commonly related to important
outcomes such as birth weight of the the baby? Deciding how to collect enough client
and service data to give useful information, without overburdening staff with
unnecessary paperwork requirements, requires a lot of planning. Larger agencies often
hire experts to design data systems, which are called MIS or management-andinformation-systems.
If you are working for an existing agency, your ability to separate out unit
costs for services or outcomes may depend on the systems that are already in place for
budgeting, accounting, and collecting service data. However, if you are in a position
to influence these functions, or need to supplement an existing system, there are a
number of texts that discuss the pros and cons of different ways of budgeting,
accounting, and designing MIS or management-and-information-systems (see Kettner,
Moroney & Martin, 1990).

Cost-effectiveness and cost-benefit studies

Most often, cost-effectiveness and cost-benefit studies are conducted at a level
that involves more than just a local program (such as an individual State
Strengthening project). Sometimes they also involve following up over a long period
of time, to look at the long-term impact of interventions. They are often used by
policy analysts and legislators to make broad policy decisions, so they might look at a
large federal program, or compare several smaller pilot programs that take different
approaches to solving the same social problem. People often use the terms
interchangeably, but there are important differences between them.
Cost-effectiveness analysis: Cost-effectiveness analysis assumes that a certain benefit
or outcome is desired, and that there are several alternative ways to achieve it. The
basic question asked is, "Which of these alternatives is the cheapest or most efficient

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Analysis

way to get this benefit?" By definition, cost-effectiveness analysis is comparative,

while cost-benefit analysis usually considers only one program at a time.
Another important difference is that while cost-benefit analysis always
compares the monetary costs and benefits of a program, cost-effectiveness studies
often compare programs on the basis of some other common scale for measuring
outcomes (eg., number of students who graduate from high school, infant mortality
rate, test scores that meet a certain level, reports of child abuse). They address
whether the unit cost is greater for one program or approach than another, which is
often much easier to do, and more informative, than assigning a dollar value to the
outcome (White, 1988).
Cost-benefit analysis: The basic questions asked in a cost-benefit analysis are, "Do
the economic benefits of providing this service outweigh the economic costs" and "Is
it worth doing at all"? One important tool of cost-benefit analysis is the benefit-tocosts ratio, which is the total monetary cost of the benefits or outcomes divided by the
total monetary costs of obtaining them. Another tool for comparison in cost-benefit
analysis is the net rate of return, which are basically total costs minus the total value
of benefits.
The idea behind cost-benefit analysis is simple: if all inputs and outcomes of
a proposed alternative can be reduced to a common unit of impact (namely dollars),
they can be aggregated and compared. If people would be willing to pay dollars to
have something, presumably it is a benefit; if they would pay to avoid it, it is a cost.
In practice, however, assigning monetary values to inputs and outcomes in social
programs is rarely so simple, and it is not always appropriate to do so (Weimer &
Vining, 1992; Thompson, 1982; Zeckhauser, 1975).

How Do Health Care Costs Impact Families and Employers?

Rising health care costs result in families cutting back on care and facing
serious financial problems. A Kaiser Health Tracking Poll found that half (50%) of
Americans say their family cut back on medical care in the past 12 months because of

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Analysis

cost concerns by, for example, relying on home remedies and over-the-counter drugs
rather than visiting a doctor (33%), skipping dental care (31 %), and postponing
getting health care they needed (28%)15 (Figure 8). Seventeen percent said they
experienced serious financial problems due to family medical bills, with 11% using up
all or most of their savings, 11% saying they have been contacted by a collection
agency, and 7% reporting being unable to pay for basic necessities like food, heat, or
housing.
Beyond actual financial hardship due to medical care, 4 in 10 Americans
(40%) report that they are very worried about having to pay more for their health
care or health insurance.

What cost analyses can tell you?

1. Cost analyses can provide estimates of what a program's costs and benefits are
likely to be, before it is implemented. "Ex-ante" or "before the fact" cost analyses may
have to be based on very rough estimates of costs and expected benefits. However, if
a program is likely to be very expensive to implement, very difficult to "un-do" once
it is in place, or very difficult to evaluate, even a rough estimate of efficiency may be
quite valuable in the planning stages (Rossi & Freeman, 1993).
2. Cost analyses may improve understanding of program operation, and tell what
levels of intervention are most cost-effective. A careful cost analysis within a program
might tell you, for example, that it doesn't so much matter whether you have a halfday program or a full-day preschool program for children, but that the teacher-to-child
ratio does matter (that is, children benefit more from low ratios than they do from
longer days). This information might influence decisions about how many teachers
you need to hire, or how many classrooms you need, or how many children you can
serve effectively.
3. Cost analyses may reveal unexpected costs. A speech therapy program might
unexpectedly find that it costs more to use paraprofessionals to work with children

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Analysis

than professionals, because the paraprofessionals need more training and supervision,
or work with fewer children at a time (White, 1988). Or, cutting the number of home
visits allowed by caseworkers serving a large rural area (in order to save on mileage
reimbursements) might have the unplanned result of higher long-distance phone bills,
because the workers still feel a need to stay in close touch with their clients.

What cost analyses cannot tell you?

1. Whether or not the program is having a significant net effect on the
desired outcomes. Unless you know for sure that the program is
producing a benefit, it doesn't make sense to talk about the cost of
producing that benefit (Rossi & Freeman, 1993). Cost analysis may be
considered an extension of an impact or outcome evaluation, but it
cannot take the place of one.

2. Whether the least expensive alternative is always the best alternative.

Often political or social values other than cost need to determine
program and policy choices. When there are competing values or goals
involved, cost analysis is often just one factor to be considered, and we
need to have some other way of deciding which factors should take
priority.

3.

Advantages of using cost analyses

1. Promotes fiscal accountability in programs. Too often, program
managers can't easily determine the cost of providing particular
services or achieving certain outcomes, because they aren't
systematically collecting the necessary data, either about clients or
about costs. At the least, programs should be able to tell funders (or
potential funders) that during a given time period, they provided a
certain level of services to a specific number of clients, and at what
cost (Jacobs, 1988).

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2. Helps set priorities when resources are limited. Program managers can
use cost information in designing programs, and in budgeting and
allocating funds to get the most out of their resources.
3. Can be extremely powerful and persuasive to legislators, policy
makers, and other funders. May help convince them to invest in
particular kinds of programs. Some argue that this advantage of costbenefit analysis may hold true even when it is not possible to assign
monetary values to all program costs and outcomes; if the effect is
strong enough, even a relatively incomplete cost-benefit analysis may
be persuasive (Barnett, 1993).

Disadvantages of using cost analyses

1. Requires a great deal of technical skill and knowledge. A true costbenefit analysis requires a solid grounding in economic theory and
techniques, which is beyond the training of many evaluators. It may be
necessary to hire a consultant if this type of analysis is desired.
2. Critics feel that many cost analyses are overly simplistic, and suffer
from serious conceptual and methodological inadequacies. There is a
danger that an overly-simplistic cost-benefit analysis may set up an
intervention to fail, by promoting expectations that are unrealistically
high, and cannot really be achieved. This may result in political
backlash which actually hurts future funding prospects instead of
helping.
3. There are no standard ways to assign dollar values to some qualitative
goals, especially in social programs. For example, how do we value
things like time, human lives saved, or quality of life?
4. Market costs (what people actually pay for something) don't always
reflect "real" social costs. For example, sometimes one person's cost is

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another person's benefit. Also, market costs don't necessarily reflect

what economists call the "opportunity costs" of choosing to do one
thing instead of another.
5. Sometimes there are multiple competing goals, so we need to weight
them or prioritize them in some way. If a program leads to
improvement in one area, but more problems in another, is it still worth
doing?
6. Sometimes costs and monetary values are considered less important
than

other,

more

intangible

values

or

program

outcomes.

7. The best-known cost-benefit studies have looked at long-term

outcomes, but most program evaluations don't have the time or
resources to conduct long-term follow-up studies.

How to conduct a cost-benefit analysis

Cost-benefit analysis is by far the most complex and controversial of the three
methods of costs analysis we have discussed. It should not be attempted by those who
lack technical expertise in this area. However, for some purposes, it is also one of the
most powerful methods. For those who decide to undertake a cost-benefit analysis in
spite of the difficulties, Barnett (1993) outlines a nine step process. Various standard
texts are recommended for more in-depth information (see below).
Step 1: Define the Scope or Perspective of the Analysis - The first step is to
describe the alternative(s) to be evaluated, and determine whose perspective will
guide the evaluation. A narrow cost analysis might look only at the monetary costs
and benefits to the individual participant or target of services, or to a particular funder
or agency. A broader perspective might attempt to look at a wide range of costs and
consequences (intended and unintended, direct and indirect) for society as a whole. A
program that is not cost-effective from the perspective of a particular agency within
its limited mission and budget may well be cost-effective from the perspective of

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society, because it saves expenses or prevents problems in other areas. Rossi and
Freeman (1993) note that because different stakeholders may have different values
and priorities, mixing different viewpoints are likely to result in "confused
specifications and overlapping or double counting." Whether we like it or not, the
perspective chosen for cost evaluation may have political implications. Therefore,
while there are limitations to any one perspective, it is important for the evaluator to
clearly state his or her position.
Step 2: Conduct Cost Analysis - The next step is to identify and estimate the
monetary value of all resources used in the intervention, not just the budgetary costs.
Some costs, such as salaries of direct service staff, rental of office space, or program
supplies, are obvious and simple to determine. Indirect costs of supervision and
administration need to be included as well. Other resources and costs may go well
beyond the items that are usually included in an agency budget. Sometimes
"overhead" (like office space or supervision) is provided as an in-kind service by an
existing agency, but since there are probably some additional demands made on the
time of the agency staff, this should be figured into the "real" cost of the intervention
(what would you have to pay if the time or space had not been donated)?. What about
the value of the time of program volunteers (what would you have to pay them if they
weren't volunteering their services)? Barnett argues that parent time is a frequently
ignored cost factor in intervention programs for children; if a high level of parent
involvement is required (for example, teaching the child, conducting physical therapy
exercises, or attending many meetings and appointments), it may represent a cost
savings to the agency, but a cost to the parent because there may be less time available
for paid work, housework, spending time with other children in the family, or just the
cuddling and nurturing aspects of being a parent.
Step 3: Estimate Program Effects - This is where more traditional impact or
outcome evaluation methods come in. As noted earlier, if we don't know that there is a
significant beneficial effect of our program, there is little point in asking how much it
costs to get the effect, or whether it is more cost-effective than another kind of
program. Many texts on evaluation can assist you in designing a valid evaluation

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(Rossi & Freeman, 1993; State Strengthening Evaluation Guide, 1997). Often it is not
possible to use a true experimental design in evaluating community-based programs,
but there are a number of quasi-experimental designs available (Cook & Campbell,
1979). Also, don't forget that it is often possible to use existing data to estimate
program effects, as well. If you are looking at an ongoing program, or one that is
based on a national model (such as the Parents As Teachers program), check to see if
formal evaluations have already been done elsewhere. You may also be able to get
useful information from the program's service statistics, or from local, state, or federal
census data [insert link here to Using Existing Data URL].
Step 4: Estimate the Monetary Value of Outcomes - This is one of the most
difficult and controversial aspects of conducting a cost-benefit analysis and it may
require the help of consultants. Some cost-savings are easier to estimate than others.
For example, we may have data that the average cost of placing a child in residential
treatment is $20,000 a year, so if we are able to prevent 20 children from being placed
in residential treatment, the estimated savings is 20 X $20,000. However, other
important outcomes may be much less obvious, and much harder to estimate.
Step 5: Account for the Effects of Time - One of the trickiest and most
technical aspects of cost-benefit analysis, especially for longitudinal studies that
follow clients or outcomes over a period of years, is discounting of costs and
calculating rates of return for alternative uses of the money (such as investing it). This
includes taking into account the effects of inflation on the value of the dollar over
time, or figuring the depreciation in the value of things like buildings and other capital
equipment. Similar issues apply in estimating the value of benefits over a period of
time. For example, if we want to look at the projected life-time earnings of a teenager
who stays in school due to a drop-out prevention program compared to one who does
not, we need to make projections about wages. If we want to look at whether the
government will eventually recover its investment in the drop-out program through
the taxes he or she will pay on the increased income, we need to make projections
about future tax rates as well. These projections all require assumptions. Unless you

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or someone on the program staff has expertise in this area, it is strongly advised that
you seek out a skilled consultant to help with this step.
Step 6: Aggregate and Apply a Decision Rule - If you are looking at the costs
and benefits on several outcomes (which is often the case), how will you decide
which has priority? If a program for pregnant teenagers results in healthier babies
(and lower hospital costs), but not in fewer repeat pregnancies, which outcome is
more important?
Step 7: Describe Distributional Consequences - This is related to choosing
your perspective of analysis. It involves specifying who gains and who loses under
different conditions (because in some cases, one party's benefit is another party's loss).
This may be a highly controversial and political step in the process.
Step 8: Conduct Sensitivity Analysis - This step involves identifying the
assumptions behind your cost estimates, and considering how critical they are to your
calculations. If one of your assumptions turns out not to be accurate, or if conditions
change during the time of your study (for example, the minimum wage goes up,
affecting salary costs), will that change your whole conclusion, or is the effect strong
enough that there is some leeway?
Step 9: Discuss the Qualitative Residual - Since there are almost always some
things that can't be quantified or given monetary values, it is important that your
report include some discussion of these issues. A frank description of some of these
qualitative issues in your report can help round out your conclusions, and reduce the
chances of your study being used inappropriately.

Question for critical thinking

1. Are Health Care Costs Growing Faster Than the Economy Overall?
If yes, then why?

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If no, then why?

2. Why is cost analysis important in health care management?

Conclusion
Health care has been at the centre of public policy reforms around the world
for some decades now. These reforms are single-minded in their goal of transforming
health care systems into more market-oriented forms, apparently oblivious of the
highly inconclusive evidence regarding the nature and causes of health policy
problems and the solutions to them. After nearly two decades of experience with
market-oriented reforms in the health sector, evidence is mounting that they have
failed to live up to expectations. In fact, there should have been no expectation of
success, given the shaky intellectual foundations on which the reforms are based. In
general, they are founded on eight essential propositions, each of which is found
wanting in some significant respect.
Policymakers face significant challenges, short and longer term, as they think
about how the nation will pay for the growing cost of health care. The health reform
legislation enacted in 2010 (the ACA) contains provisions designed to achieve health
care cost containment. But there are so many facets to health care reform - expanding
coverage for the uninsured, reducing health care costs for individuals and employers,
controlling entitlement spending for government programs such as Medicare and
Medicaid, and reforming the health care delivery system, to name a few - that it is
unclear how cost containment provisions will prosper in the dramatically changing
health care environment. Successfully improving the efficiency and quality with
which care is delivered is an enormous challenge, one that will require substantial
investment in research, new information systems, performance incentives, and
education, with the hope of transforming how health care is delivered by thousands
and thousands of providers dispersed across our largely disaggregated health care
system. Coming to terms with the potential of medical technology and its long-run
influence on costs is a different type of challenge, but one that is also important. The
advances in health care that have occurred over the past half-century have increased

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how long we live and have reduced the burden of disease for countless people.
Developing the philosophical, ethical, and political framework necessary to balance
the benefits of future advances with our ability to pay for them is one of the next great
challenges for health policy.

Referrences
1. Barnett, W. S. (1993). The economic evaluation of home visiting programs. The
Future of Children: Home Visiting, 3. Center for the Future of Children, the David
and Lucile Packard Foundation, 93-112. http://www.futureofchildren.org
2. Barnett, W.S. (1985). Benefit-cost analysis of the Perry Preschool program and its
policy implications. Educational evaluation and policy analysis, 7. 333-342.
3. Berreuta-Clement, J. R., Schweinhart, L. J., Barnett, W. S. , et al. (1984). Changed
lives: The effects of the Perry Preschool program on youths through age 19.
4. Callor, S., Betts, S. C., Carter, R., & Marczak, M. (1997). State Strengthening
Evaluation

Guide.

Tucson,

AZ:

USDA/CSREES

&

University

of

Arizona.ttp://ag.arizona.edu/sfcs/cyfernet/cyfar/evalgde.htm
5. Cook, T. D., & Campbell, D. T. (1979). Quasi-experimentation: Design and
analysis issues for field settings. Boston: Houghton-Mifflin Co.
6. Jacobs, F.H. (1988). The five-tiered approach to evaluation: Context and
implementation. In H.B. Weiss, & F.H. Jacobs (Eds.), Evaluating family programs.
New York: Aldyne de Gruyter.
7. Kettner, P. M., Moroney, R. M., & Martin, L. L. (1990). Designing and managing
programs: An effectiveness-based approach. Newbury Park, CA: Sage.
8. Mishan, E. J. (1988). Cost-benefit analysis (4th ed.). London: Unwin Hyman.
9. Rossi, P. H., & Freeman, H. E. (1993). Evaluation: A systematic approach (5th ed.).
Newbury Park: Sage Publications, pp. 363-401.

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10. Thompson, M. S. (1980). Benefit-cost analysis for program evaluation. Beverly

Hills: Sage.