FAQ: What Is Cost-Budget Analysis?

Updated April 20, 2023

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Project managers use a variety of tools to ensure the successful planning and execution of projects. Before they begin planning the project, project managers first assess the potential success of a project. Cost-budget analysis, more commonly known as cost-benefit analysis, is a tool that may help them do so.

In this article, we discuss the definition of cost-benefit analysis or cost budget analysis, describe the benefits and drawbacks of using cost-benefit analysis and provide similar concerns.

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What is a cost-benefit analysis?

A cost-benefit analysis, or cost budget analysis, is a systematic process to evaluate the benefits versus costs of projects. It's a tool that project managers may use to provide an evidence-based review and analysis of a project without considering biases, opinions or politics. It involves identifying and quantifying all the relevant costs and benefits associated with the project and then comparing them to determine whether the benefits outweigh the costs. A cost-benefit analysis also accounts for opportunity costs to help determine which projects have the highest payoffs. You can also refer to it as a benefit-cost analysis.

Related: What Is Cost Analysis? (Plus How To Calculate in 7 Steps)

When do you use a cost-benefit analysis?

Cost-benefit analysis can assist with ensuring you make well-informed business decisions, so it's important to perform before making decisions when there are multiple options available and decision-makers want to determine which option is the most cost-effective or the most rewarding. It allows you to determine if a project is feasible and justifiable by assessing if the benefits of the project outweigh the costs. You may also use it to create a baseline for comparing projects to establish which project offers the strongest benefits that best outweigh the costs.

You may also consider using cost-benefit analysis when:

  • Assessing investment opportunities

  • Evaluating new hires

  • Evaluating the value of new change initiatives

  • Measuring the effectiveness of a social program

  • Quantifying effects on participants and stakeholders

  • Surveying the desirability of newly suggested policies

  • Evaluating the costs and benefits of public infrastructure programs

Related: 5 Project Management Steps (Plus Tips for Success)

What are the benefits and drawbacks of cost-benefit analysis?

Here are some benefits and drawbacks of using cost-benefit analysis:

Benefits of cost-benefit analysis

Cost-benefit analysis may be useful for evaluating small- to mid-level expenditures. It provides a data-driven guide to assist with allowing stakeholders to assess whether the benefits justify the costs. This helps simplify the decision-making process by reducing business decisions to choosing the option with more benefits than costs.

Cost-benefit analysis evaluates each benefit and cost a project may have and allows you to standardize and quantify it. This provides you with the opportunity to uncover benefits and costs you may not have previously considered. Cost-benefit analysis takes into account both the quantifiable and nonquantifiable benefits of a project, such as environmental, social and health effects.

Related: Four Examples of Sunk Cost

Drawbacks of cost-benefit analysis

Cost-benefit analysis may not be effective for larger projects because it may not accurately account for all financial concerns, especially how finances may change. It does not account for uncertainties like:

  • Income level

  • Inflation

  • Interest rates

  • Present value of money

  • Varying cash flows

While cost-benefit analysis is data-driven, it doesn't necessarily account for benefits not directly convertible to cash amounts. Similarly, value is subjective, meaning the value of intangible benefits may be debatable. Stakeholders or other important parties may try to influence the cost-benefit analysis, as it may be susceptible to manipulation or bias. Using net present value (NPV) may help you better account for these concerns. Cost-benefit analysis also has an inherent cost associated with it. It requires time and money to complete, such as the labor costs required to hire an analyst.

Related: How To Calculate NPV: Definition, Formulas and Examples

What categories are costs and benefits sorted into?

Here are the categories of costs and benefits:

Cost categories

Categories for costs may fall into categories like:

  • Direct costs: Direct costs are costs associated with producing a cost object, such as an activity, customer, product, project or service.

  • Indirect costs: Fixed costs not associated with the direct production of a product or service, such as overhead.

  • Intangible costs: Intangible costs are costs that can be identified but are not easily quantifiable, such as changes in customer satisfaction, employee morale or productivity.

  • Opportunity costs: Opportunity costs are the potential benefits foregone when you choose one option over another, such as choosing to purchase and renovate a plant rather than building a new one.

  • Real costs: Real costs are the actual expenses associated with producing an offer, such as raw materials and labor costs.

  • Tangible costs: Tangible costs are costs that are easily identifiable, measurable and quantifiable, such as payroll, purchasing tools and rent.

Related: Understanding Total Cost of Ownership: A Guide to TCO Analysis

Benefits categories

Benefits may fall into similar categories, and examples of these benefits may include:

  • Competitive: Being the first within an industry with a product

  • Direct: Earning an increase in revenue or a boost in sales

  • Indirect: Gaining an increase in customer interest

  • Intangible: Improving employee safety

Related: Cost-Volume-Profit Analysis (With Formula and Example)

What are some tools used in cost-benefit analysis?

Projects may require different tools for cost-benefit analysis, such as:

  • Benefit-cost ratio: Summarizes the overall relationship between the benefits and relative costs of a proposed project

  • Forecasting techniques: Estimates of the project cost, duration, quality of deliverables or other factors

  • Regression modeling: Statistically estimates relationships between dependent and independent variables

  • Valuation: Estimates approximate values of assets

Related: How To Use the Cost-Benefit Formula (With Example)

How accurate is cost-benefit analysis?

The accuracy of cost-benefit analysis may vary. If you use accurate data and estimates during the process, your results are more likely to be accurate. Inaccuracies may occur if you:

  • Assess your project with a subjective perspective

  • Cannot ignore your confirmation bias

  • Fail to use proper problem-solving methods to determine intangible costs

  • Only use data that supports the results you want to achieve

  • Rely too heavily on data from past projects

  • Use too much data from past projects that differ from your current project

Related: How To Do Project Cost Analysis (With Example)

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Why is cost-benefit analysis important for project management?

Cost-benefit analysis provides you with an unbiased method for evaluating benefits, costs and profits. It may effectively help you determine the feasibility of your project. By proving your project is sound and feasible, you may be able to better get the support you need from stakeholders and upper management or control and evaluate the progress of your project.

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