What is a Cost-Benefit Analysis?

A Cost-Benefit Analysis (CBA), also known as a Benefit–Cost Analysis, is a tool we use to help us weigh the pros and cons before committing ourselves to buying something, implementing a new policy, investing in new technology, undertaking a public infrastructure project, or starting a new project, among other applications.

Imagine you are trying to decide whether to buy a new car. That is a big question with both benefits and costs. A cost-benefit analysis helps you weigh those factors before deciding.

In an article published by Harvard Business School Online, Tim Stobierski wrote the following definition of the term:

“A cost-benefit analysis is the process of comparing the projected or estimated costs and benefits (or opportunities) associated with a project decision to determine whether it makes sense from a business perspective.”

“Generally speaking, cost-benefit analysis involves tallying up all costs of a project or decision and subtracting that amount from the total projected benefits of the project or decision (sometimes, this value is represented as a ratio).”

Brief history

Jules Dupuit (1804-1866), a French civil engineer and economist, was the first to write about the concept of CBA in 1848. Alfred Marshall, 1842-1924), an influential British economist, formalized the term in subsequent works.

Before deciding whether to proceed with a project, Dupuit wrote that we should calculate “the social profitability of a project like the construction of a road or bridge.”

Scales with coins on one side and a lit lightbulb on the other, plus a definition of COST-BENEFIT ANALYSIS.
Image created by Market Business News.

How Does a Cost-Benefit Analysis Work?

A CBA process goes as follows:

  • Identify the Choices

What choices or options do you have? If you are wondering whether to buy a new car, your options may be keeping your current one, purchasing a new one, or looking at used vehicles.

  • List the Costs and Benefits

List every potential cost and benefit next to each option. Costs are what you give up, including effort, time, and money. Benefits are what you gain, such as better features, reliability, etc.

  • Be Specific – Use Numbers

Whenever possible, make it measurable, that is, try to put numbers on things. Placing a number next to the cost of a new car is easy – if its retail price is $30,000, that is the cost.

Some things are harder to measure. For the joy of driving a new car, you could estimate a value you would be willing to pay for that benefit.

  • Compare and Decide

Analyze whether the total benefits for each option outweigh the total costs. You can do this either by just looking at your list and visually weighing the benefits against the costs, or using a more detailed calculation method.

Why Use a Cost-Benefit Analysis?

  • Data-Driven Decisions

It can help you make smarter decisions based on careful analysis rather than just a gut feeling or whim.

  • Uncovers Hidden Factors

A CBA makes you think about indirect costs or benefits you might otherwise miss, such as future repair costs or the impact on your commute time.

  • Not Just About Money

While a CBA often involves money, it also helps you assess ‘intangibles’ – the things that are hard to measure with cash, but still important to you. Examples include comfort, the personal satisfaction and pride of owning a brand-new car, and the convenience of modern features.

Real-World Examples

Governments, businesses, the military, other organizations, and individuals use CBAs all the time:

  • A Business

A company might do a CBA to decide whether opening a new factory is worthwhile.

  • A Local Authority

A city government may weigh the costs against the benefits for the community when analyzing a new park project.

  • An individual

You could use a cost-benefit analysis to decide whether to look for another job, emigrate, go back to school, purchase a home, start a new business, or invest in personal health and fitness initiatives.

  • The Military

A military general might conduct a cost-benefit analysis when deciding whether to proceed with a strategic operation. They would need to consider such factors as the expenditure of resources, the risk to personnel, the probability of success, and the overall impact on national security objectives.

Final Thoughts

A cost-benefit analysis is not a silver bullet (magic answer), it is a tool. The quality of your result depends on how well you identify the costs and benefits and how accurately you calculate them.

It is a tool that can help you make informed, well-considered decisions across all facets of your life.