Tackle Big-Picture Projects Using a Cost-Benefit Analysis
Start at the bottom.
That’s what legendary basketball coach John Wooden did every year. Wooden did not start with layups or defensive strategy – he started with shoelaces.
Coach Wooden, who won 10 championships in 12 years with U.C.L.A., had a reputation for fortifying the fundamentals before moving forward. Before his athletes played, they had to practice pulling up their socks, leaving no loose flaps in the sneakers, and pull laces tight to avoid ankle sprains.
“He didn’t want blisters,” said former player Rich Levin. “I mean, that’s not a serious illness, but you could miss a game or two.”
Whether you’re a new business owner or a seasoned veteran, sometimes we all need to start at the bottom.
Have you refreshed the fundamentals of your business plan lately? Managing finances is essential to success, and one tool of the trade is a cost-benefit analysis. Whether you’re considering a new venture or weighing a staffing decision, a cost-benefit analysis can help you decide which projects to tackle and what resources are needed.
The Basics of a Cost-Benefit Analysis
When you perform a cost-benefit analysis (CBA), you make a comparative assessment of all the benefits you anticipate from your project and all the costs needed to implement and support the changes this brings.
Here are four steps to account for revenue and expenses in your CBA:
1. Prepare a Balance Sheet
Begin by carefully examining your costs and expenses (or money-in, money-out).
After you categorize expenses in your balance sheet, you are ready to weigh upcoming business decisions with a rubric that puts potential benefits and costs in context.
2. Give Dollar Values to Anticipated Costs & Benefits
A CBA, in a nutshell, means adding money in benefits plus money in costs over a set period of time.
A functional CBA seeks to express benefits and costs in monetary equivalents. Some CBA’s are easy to quantify. For example, adding new seating to your restaurant might incur a one-time expense of $60,000, but result in $7,000 of extra sales each month.
Clearly, those benefits outweigh the costs.
Some CBAs are more complex. Perhaps hiring a team member will cost $40,000, but the increased sales and productivity are hard to estimate. In this case, do your best to express benefits and costs in monetary terms to facilitate the assessment of a project’s net value.
3. Weigh Future Values or Expenses
As you build your CBA, remember to make projections for all phases of the project.
Some of your costs may occur only once (like capital investment, equipment purchases, etc.), and others will be recurring (like staffing, maintenance, or increased utility bills). The farther into the future you look, the more important it is to convert the net value (of benefits over costs) into today’s dollars. As you refine your CBA, consider inflation, interest rates, and even opportunity costs (the potential benefits that might be lost by passing on a different project in favor of this one).
Here you may want to run a sensitivity analysis, which is a “what if” analysis that goes back to your CBA and plays around with assumptions. For example, if you had uncertainty about sales projections, you could vary projections by several percentage points before re-running the analysis.
4. Make an Informed Decision
Now it’s time to compare total costs to total benefits and make a decision.
Do benefits outweigh costs? Do they do so significantly? In this case, you should green-light the project. If more capital is needed, you’ll need to rethink your goals or form a new strategy.
No matter what the decision, a CBA can be critical to the success of any project, allowing you to make non-critical choices and keep your business running smoothly!