Cost-Benefit Analysis

By Entrepreneur Staff

Cost-Benefit Analysis Definition:

A process by which you weigh expected costs against expected benefits to determine the best (or most profitable) course of action

When it comes to goal setting or deciding on the best plan of attack, working up a cost-benefits analysis will help you decide just which route would be best for you. And a cost-benefit analysis doesn't have to be complicated. You simply draw a line down the middle of a piece of paper to create two columns. On the left, list the benefits of achieving a given goal. On the right, list what it will cost you to get there. Once you've done that, you can simply add up the benefits and costs columns and see which has more, or assign weighted scores to each entry and total them at the bottom. Of course, you may not want to let this quick and easy analysis make the final decision for you. And it may sometimes be the nearest thing to a tossup. But even a simple cost-benefit analysis can give you an idea of whether a given goal is worth investigating further.

An example is a sales director who needs to decide whether to implement a new computer-based contact management and sales processing system. The sales department currently has only a few computers, and its salespeople aren't computer savvy. Any system upgrade would require extensive employee training. The company is likely to experience a drop in sales during the transition period.

While total expenses, including equipment, installation and training costs, plus lost productivity, are estimated to be $55,800, the company's analysis reveals the new computer system would increase sales capacity, boost efficiency and enhance customer service and retention--financial benefits the company pegs at $90,000 annually. Based on the cost-benefit estimates, the company would see a return on its investment in eight months. (Payback time: $55,800 ? $90,000 = 0.62 of a year.)

More From Financial Management

Cash Float Accounts

A bank account specifically set up by a business owner to float money through from Business A to enhance the perceived value of Business B

Cost-Benefit Analysis

A process by which you weigh expected costs against expected benefits to determine the best (or most profitable) course of action

Assets

The value of any tangible property and property rights owned by a company less any reserves set aside for depreciation. Assets don't reflect any appreciation in value unless they're sold for the greater value.

Debt-to-Equity Ratio

A measure of the extent to which a firm's capital is provided by owners or lenders, calculated by dividing debt by equity. Also, a measure of a company's ability to repay its obligations. If ratios are increasing--more debt in relation to equity--the company is being financed by creditors rather than by internal positive cash flow which may be a dangerous trend.