Cost-Benefit Analysis Defined – The

Ultimate Guide
 Scott Beaver | Senior Product Marketing Manager
April 9, 2021

In any business, department heads have competing priorities. For example, the chief
revenue officer of a B2B software-as-a-service provider wants to establish an indirect
channel sales program, while marketing wants to hire a content writer to help
organically acquire new leads. Both make good cases — each department is sure they
can increase revenue with a few more people and a little more money, after all.

Finance teams acting as mediators should consider a formal cost-benefit analysis

exercise. Also sometimes called a benefit-cost analysis, this is a well-established
process for guiding leaders to make decisions that are rooted in and informed by data
on company goals and priorities and budget realities.

What Is Cost-Benefit Analysis (CBA)?

A cost-benefit analysis involves comparing the explicit and implicit costs of taking an
action versus expected benefits. The process of gathering that information may be
enlightening in itself because it may require the business to assign monetary value to
factors that don’t have explicit costs. The resulting analysis allows decision-makers to
weigh all information and make rational choices.
As a pros-and-cons evaluation tool, CBAs are most closely associated with public-
sector decision-making. But they’re also used in business when it comes time for
project planning around adding employees, purchasing technology or equipment,
expanding facilities and more. A CBA can weigh the benefits of taking an action over
maintaining the status quo or help a business compare two or more options to see
which one makes the most sense.

Key Takeaways
 Cost-benefit analyses help businesses weigh pros and cons in a data-driven way so they can
make complex decisions in a systematic manner.
 For a successful CBA, leaders need to identify and project the explicit and implicit costs
and benefits of a proposed action or investment.
 It’s also a good idea to assign someone to make the case for the status quo as a way to
compare the opportunity cost of doing nothing and investing cash versus proposed actions.
 A cost-benefit analysis is only as good as the data on which it’s based, so companies with
more mature financial reporting have a higher likelihood of success.

Cost-Benefit Analysis Explained

Each action a business takes has explicit cost and revenue expectations. But there are
also implicit costs, often expressed as the opportunity cost — that is, the money or
other benefit lost by pursuing one option over another or of taking no action.
Opportunity cost is not an accounting concept, it’s an economic one, but it can be
associated with a quantitative value.

A cost-benefit analysis adds up the benefits and costs of a program or purchase,

extracts a CBA ratio and then compares that result with both stasis and alternative
programs or purchases.

A CBA requires considering both monetary and opportunity costs over a period of
time. To compare multiple CBAs, extract a CBA ratio from each. The formula for a
cost-benefit analysis ratio can be expressed as:
 Projected benefits / projected costs = CBA ratio

For example, the CMO of our fictional SaaS provider wants to hire a content writer to
improve the company’s web site content so that it helps deliver more qualified leads
to sales. The CRO thinks a channel program can win both new customers and more
mindshare. In all cases, the leaders would be asked to approve at least one additional
FTE along with some required software and other services.identify and attach dollar
values to the explicit and implicit costs of their projects and compare those to the
explicit and implicit benefits. The CFO may also run the numbers on “none of the
above.”

If that sounds straightforward, it isn’t. An in-depth, precise cost-benefit analysis is a

complex undertaking because of the inputs required, the need to set parameters, the
fact that not every factor the business needs to measure has an explicit cost or return
and the number of indirect or intangible properties that make future outcomes difficult
to forecast.

Then there’s the fact that while a project or purchase with a high benefit-to-cost ratio
is generally considered the most favorable option, that’s not a given.

Purpose of a Cost-Benefit Analysis

Businesses perform cost-benefit analyses to help leaders remove emotion from
assessments and provide an apples-to-apples basis to compare competing priorities.
And, when intangible benefits are expressed as a “benefits value,” with dollar
amounts assigned, that helps finance calculate a break-even point — the time it takes
for a product’s or purchase’s benefits to exceed the cost.

In the future, a CBA can be revisited to evaluate the actual cost and ROI of a project
or purchase compared with projections and improve the analysis process.
For example, the CMO’s plan to employ a writer to attract new customers involves
recurring investments in both marketing software subscriptions and salary and
benefits. Expected returns include increased revenue, a larger customer base and
better visibility for the company. Some of these costs and returns are difficult to
quantify. In contrast, the CROs ’plan will require the attention of sales leaders to
create an entirely new revenue stream that may take a year or two to become
profitable. There’s a substantial opportunity lost in pursing more sales through
existing channels, but the payoff could be substantial. There’s also the internal
dynamic that will surface as the new indirect sales channel takes some of the revenue
of the existing sales team.A CBA seeks to select the project with the greatest overall
benefit for the incurred costs.

Importance of Cost-Benefit Analysis

Leaders need to make sometimes difficult decisions in a timely manner. Cost-benefit
analyses help by providing financial context and data-driven justification for
sometimes painful choices that may not be viewed favorably by staff.

A cost-benefit analysis, often paired with the sensitivity or “what if” analyses used
in financial modeling, also offsets biases that may sway decisions, like the dreaded
HiPPO — highest-paid person’s opinion.

Sensitivity Analysis Template

Below is a sample sensitivity analysis worksheet a CIO might use to evaluate a

product purchase alongside a CBA — it’s overly simplified for the sake of space. It
combines product attributes, like suitability for the task, with business considerations.
Criteria sets may be added and customized.

Sensitivity Analysis Table for Product Purchase

 Measurement 1 = poor, 10 = excellent

Product Attributes Business Impact

Product category under consideration (Criteria set 1) (Criteria set 2)

OPTION 1    

OPTION 2    

OPTION 3    

Criteria set 1 = Match to needs, reliability, value for price, competitive positioning, roadmap/innovation,
integrations
Criteria set 2 = Assists with customer acquisition, adds operational efficiency, staff familiarity, loaded
cost

But leaders do need to go beyond the numbers and consider intangibles: Which
project or purchase better advances the business’s long- and near-term goals? For
example, our fictional CMO makes a strong case, but if the company wants to
undertake expansion, whether geographically or selling into a new market segment or
industry, the indirect sales channel program championed by the CRO may be the
better choice with a bigger eventual payoff, even though accurately comparing the
cost of direct versus indirect sales is a complex analysis.

Point is, data needs to play a strong yet balanced role in the decision-making process.
By allowing a company to better weigh the implicit costs of taking or not taking an
action, where there is no obvious or immediate explicit cost, projects that may not
generate a clear profit on the balance sheet may still be moved forward. Think
advancing sustainability objectives, diversity and inclusion initiatives and helping
employees navigate new workplace realities.

When Should a Business Conduct a Cost-

Benefit Analysis?
CBAs are useful anytime there are priorities competing for limited resources. But
companies do need to set some ground rules for analyses. For example, all
stakeholders should understand the company’s expectation on whether a CBA will
address short-, mid or long-term impacts. The further into the future analysis extends,
the more difficult it is to accurately forecast costs and benefits.

In general, most companies should do a cost-benefit analysis for major decisions in

these five areas:

Capital investments: Should the business purchase a new delivery vehicle,

production machinery, computer hardware or office furniture, or invest in renovating
a building? Assign costs with the understanding that the benefit of the investment is
derived from the use of the asset, not from its market value. For instance, an
investment in new manufacturing equipment should allow me to produce more goods
at a lower cost, resulting in more revenue and better margins. I'll retain this benefit
even as the value of the equipment declines.

Business process change: A business process is any defined set of actions that are
repeated often and produce a desired result. A company may think that a task that’s
high volume, high touch, repetitive and prone to error is a candidate for business
process automation. A CBA can help prove the theory. For example, should you
purchase software that automatically adds inventory receipts to the inventory ledger
and the asset column on the balance sheet versus manual entry? Or, a growing
company may run a CBA and find that hiring a third-party to manage the payroll
process now makes sense and is a source of savings.

In any cost-benefit analysis, ensure the stakeholder asks: How can we drive
inefficiency out of this business function? And how do we attach a dollar value to
that?

Organizational change: This is often related to business process change and refers to

human capital. An example is comparing hiring staff versus outsourcing. Adding an
indirect sales channel, for example, is a significant organizational change. For a CBA,
you’ll need to consider that a productive on-staff sales rep might cost more on a per-
sale basis versus indirect, but turnover is high. Commissions may be a wash. Will you
need to hire a channel manager (organizational change), set up a portal for functions
such as deal registration (a business process change) and/or allocate marketing
development funds?

Adjusting pricing or introducing new product or service: Managers in companies

that use cost accounting have pretty granular data on the total costs and revenue
attached to a good or service and thus have a head start on cost-benefit analyses.
Factors to quantify may include whether the company should introduce a subscription
model, or whether it should discontinue a certain product or service because of poor
sales before adding a new SKU.

Entering into a merger, acquisition or divestiture: Decisions around whether to

acquire or merge with a company or sell parts of the business are among the most
complex analyses, and the most important. A merger that may seem desirable at first
glance, upon further consideration, may come with significant process and
organizational changes, legal fees, costly layoffs and other factors which may
diminish the relative value of the merger.

5 Cost-Benefit Analyses Gotchas to Avoid

1. One person’s opinion: Applying a monetary value to intangible risks and benefits requires
human judgment and is therefore subjective and prone to bias. The more people who weigh
in, the more objective the analysis is likely to be. For important CBAs, assemble a panel
with a mix of expertise — HR, engineers and new and longtime employees.
2. Dubious data sources: Even line items that should be readily quantifiable may be open to
interpretation in the absence of accounting and financial management software. If the
quality of data is in question, apply a sensitivity analysis or other valuation method to
formalize how the company measures uncertainty for CBA purposes.
3. Unrecognized resource constraints: A CBA on hiring a content producer, for example,
must recognize the limited number of skilled writers available and the volume of content
that one employee can produce. Likewise, lowering the cost of a product may increase
consumer demand beyond what the supply chain can bear, thus raising COGS — if an
existing supplier can't support increased demand, the manufacturer will either sell out of
product or be forced to pay a higher price to purchase raw materials.
4. Extended timelines: In general, three years is doable; five years is a stretch. Adjust for
extended projections by A: Applying discounted or present value. Select a reasonable
interest rate at which future earnings are to be discounted to reduce them to their present
value, and use that rate in all analyses. And B: Applying scenario analysis, which provides a
rational and structured way to analyze the future and account for externalities.
5. Double counting benefits or costs: For example, if an anti-phishing project is predicted to
reduce the likelihood of a successful ransomware attack on a SaaS provider, the CIO might
be tempted to include both the benefit of increased uptime for the business and higher
 productivity for employees, yet the cost of downtime probably already includes lost
productivity.

What Inputs are Included in a Cost-Benefit

Analysis?
In performing a cost-benefit analysis, include:

Costs
The costs of taking an action or of doing nothing include:

Explicit costs: These are accounting costs with explicit monetary value and may
include direct costs such as labor, manufacturing and the cost of software or
machinery and indirect costs, such as utilities or rent.

Intangible costs: These are qualitative items, such as lost productivity or reduced

customer satisfaction if an existing product is retired because a new SKU is being
introduced.

Implicit costs: These are opportunity costs, both financial and non-financial, like
purchasing a capital asset versus investing free cash, or of pulling employees off one
project to work on the new initiative.

Benefits
As with costs, benefits should be categorized:

Direct benefits: This is the accounting profit from the decision and could include, for
instance, cost savings or increased revenue from a new product or service.

Indirect: These are tangential benefits. For instance, as a result of a new technology

implementation, customers may be incentivized to spend more.

Intangible: These benefits could include, for instance, improved customer

satisfaction, employee morale or employee safety.
Competitive: The business may want to include in its CBA the benefits of gaining a
competitive edge in its industry and factor in, for example, increased market share,
thought leadership and first-mover advantage.

Pros and Cons of a Cost-Benefit Analysis

A well-conducted cost-benefit analysis provides a level of predictability when
undertaking a project. However, leaders need to set parameters and ensure all
participants are working with a common set of assumptions.

Advantages of cost-benefit analyses:

 It supports decision-making with data to increase confidence or build support for making
a move.
 It provides a way to incorporate qualitative factors into quantitative analysis.
 It can help businesses arrive at the total cost of taking a particular action that eclipses its
explicit price tag and contributes to determining the ROI of a project or action.
 By incorporating net present value, businesses may view future investments at current
dollar values.
Challenges of cost-benefit analyses:
 It requires assigning explicit monetary value to intangible factors. This can be challenging
and introduce ambiguity.
 Gathering accurate data may be challenging, as is forecasting implicit cost and benefits.
 Businesses can become over-reliant on CBAs as a tool for making decisions and as a
project-costing and budgeting method.
 Forecasting is inherently difficult. Unless a company regularly performs financial
planning & analysis (FP&A) and scenario planning exercises, it should use caution with
extended-outlook CBAs.

How to Conduct a Cost-Benefit Analysis

Companies may need to expand the CBA process based on the complexity of the
proposals under consideration, but the basic steps are:
 1. List the projects, investments or actions to evaluate, and identify all stakeholders. Ensure
each stakeholder has access to the financial data that will be needed to evaluate the project
or investment; understands parameters, such as how far into the future to extend the
analysis; and has insights into intangibles, including access to FP&A and scenario planning.
2. Determine costs. List all explicit and implicit costs of each action under consideration and
assign dollar values to the implicit, or opportunity, costs. For example, if current IT
employees are redirected to installing and running new security software, what tasks will no
longer be performed?
3. Document assumptions. Valuing implicit costs and benefits requires a certain amount of
judgement. Any assumptions used to estimate the values should be clearly documented
before comparing alternatives.
4. Determine benefits. List and assign dollar values to all explicit and implicit benefits of
each action under consideration. As with costs, this will be easier for benefits that can be
quantified, for example, in terms of saving FTE costs for one or more sales professionals by
launching an indirect channel sales program. Others, such as employee productivity or
engagement, will be more challenging to quantify. Bring in HR or other experts as needed
to check stakeholder assumptions.
5. Add perspective. Not everything is a purely dollars-and-cents decision. Senior leaders need
to weight options based on company culture, values and goals.
6. Compare alternatives. Calculate the cost-benefit analysis ratio for each option under
consideration and compare those against one another and against the costs and benefits of
doing nothing.

Cost Benefit Analysis Example

Let’s look at a simplified version of the CBA that the head of sales presented for
establishing an indirect channel.

Our fictional SaaS provider has a traditional direct sales model, where its asset
maintenance scheduling software is sold as service directly to end customers.
Customers may also purchase direct from the website, which does not generate a
commission.

Goal: The company sells mainly to manufacturers but believes it can expand to serve
healthcare groups, which need to perform regular maintenance on expensive medical
equipment.
The problem is that the sales team would need to start from scratch to make contacts
in this new market. The CMO believes her marketing team can generate sales-
qualified leads by hiring a content producer familiar with healthcare, but the chief
revenue officer thinks there’s a better way.

Premise: The CRO believes the company can more quickly succeed by establishing
an indirect sales channel to complement existing sales capabilities. The program
would be open to 10 to 15 value-added resellers and managed service providers that
focus on healthcare. The CRO would sign on the partners initially then pass them to a
channel salesperson. The company would develop an online portal for partners to
register opportunities and execute purchases on behalf of customers.

Note: The numbers below are designed to be illustrative, not a representation of the
industry.

Assumptions: The software costs $15000 per year fifty seats – an average sale. The
CRO believes that the partner program can bring in 50 new customers in Year 1 and
that all will renew. By year three, the partners will bring in 200 new logos per year.
Partners earn 20% of sales. Support will take1 $70,000 FTE specialist per 75 logoss.
The product for indirect sale is the same as what is sold through the direct sales
channel, and pricing will be the same. To avoid channel conflict, direct sales wouldn't
be allowed to work deals in certain verticals. And they won't follow up on website
leads for for those verticals.

Year 1 Cost Income Notes

Develop Portal $50,000   One time expense

App Hosting $6000   Share of App deliver costs

Commissions to Partners (50 sales) $150,000   Partner sales numbers grow each year

Channel management team $150,000   First year, 1 channel manager

1 Support FTE $70,000   Each can support 75 users

 Year 1 Cost Income Notes

25% CRO comp to launch $50,000   Moves to channel team next year

Revenue 50 customers   $750,000  

First Year total $476,000 $750,000 Gross Profit $274,000

Portal maint $10,000   Bugs, security, etc

App Hosting $18,000   Proportional to sales

Commissions (50 existing + 100 New) $450,000   Channel partners are better at selling af

Channel management $300,000   One leader and two channel managers

2 support FTEs $140,000    

Revenue 150 customers   $2,225,000 Assume no attrition

Second Year Total $918,000 $2,225,000 Gross Profit $1,307,000

Portal maint $10,000   Bugs, security, etc

App Hosting $42,000   Proportional to sales

Commissions (150 existing + 200 New) $1,050,000   Channel partners are better at selling af

Channel management $300,000   One leader and two channel managers

2 support FTEs $350,000    

Revenue 350 customers   $5,250,000  

Third Year Total $1,752,000 $5,250,000 Gross Profit $3,498,000

 Year 1 Cost Income Notes

Total $3,296,000 $8,225,000 Gross Profit 5,079,000

Gross Margin 62%

In contrast, the CMO’s proposal would entail gaining those 50 new healthcare
customers by spending $100,000 on an FTE plus $250,000 on new marketing tools
and ad buys.

History of Cost Benefit Analysis

Engineer turned economist Jules Dupuit is considered the founder of cost-benefit
analysis theory. Dupuit put forth the idea in 1844, but use of cost-benefit analyses
didn’t gain popularity as a determining factor in public policy decisions until much
later, in the 1980s.

Federal agencies are now required by law to conduct cost-benefit analyses to study the
implications of policy across a broad range of areas — transportation, public health,
criminal justice, defense, education and the environment. These agencies are often
called upon to apply dollar values to intangibles, such as the value of clean air or safer
highways.

Companies that work with public-sector customers may be more familiar with the
CBA process, but all businesses can benefit.

Free Cost Benefit Analysis Template

Download this free cost benefit analysis template to help narrow down your options
and make complex decisions simpler.

Get the free template

Manage Your Cost Benefit Analysis with
Accounting Software
The most important contributor to an accurate, insightful cost-benefit analysis is
accurate data. Modern finance and accounting software combined with integrated
planning, budgeting and forecasting tools and enterprise resource planning software
suites with HR, supply chain and other insights mean all transactional and forward-
looking data is in a central location. This makes it easier for authorized stakeholders
to pull accurate, up-to-date information to inform their analyses. Numbers can be
automatically exported to Excel or provided in the form of a report to key decision-
makers.

Perhaps one of the more challenging parts of a CBA is when a leader selects a project
that the numbers say is less profitable than other options. The reason may be a desire
to forward long-term goals, or that company culture and values dictate spending more
or leaving profit on the table.

And of course, sometimes the right answer will be “do nothing.” At least with a solid
cost-benefit analysis, companies can make hard decisions with their eyes wide open.