Decisions Use Cost Benefit Analysis
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.
- 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 product or service.
- 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.