INTRODUCTION

Cost benefit analysis (CBA) is one of the main ways that economists analyse major development proposals and environmental problems. This technique commonly applied in finance. Works by identifying all the costs and benefits that would result from a particular resource use. These include non-money costs and benefits. In other words, Cost benefit analysis (CBA) is a process by which you weigh expected costs against expected benefits to determine the best (or most profitable) course of action. The benefits of a given situation or business- related action are summed and than costs associated with taking that action are subtracted. Cost benefit analysis (CBA) has two purposes : 1) To determine if it is a sound investment/decision (justification/feasibility) 2) To provide a basis for comparing projects. It involves comparing the total expected costs of each option against the total expected benefits, to see wether the benefits outweight the costs, and by how much.

HISTORY OF COST BENEFIT ANALYSIS

The idea of this economic accounting originated with Jules Dupuit, a French engineer whose 1848 article is still worth reading that is " On the Measurement of the Utility of Public Works", is often cited as the first work on CBA. However, as early as 1808, the "Report on Transportation" by Albert Gallatin (the fourth U.S. Secretary of the Treasury) had recommended the comparison of costs and benefits for evaluating water-related projects.

Economic analysis of social benefits and costs in federal projects was instituted in 1936 by the Flood Control Act, which required the U.S. Army Corps of Engineers to evaluate all benefits and costs of water resource projects "to whomsoever they accrue." The first federally mandated guidelines for CBA of public projects were issued in 1952 by the Bureau of the Budget. Gradually the bureaucratic emphasis expanded to include all public goods.

PRINCIPLES OF COST-BENEFITS ANALYSIS

The principles of cost-benefit analysis (CBA) are simple:

1. Appraisal of a project: It is an economic technique for project appraisal, widely used in business as well as government spending projects (for example should a business invest in a new information system) 2. Incorporates externalities into the equation: It can, if required, include wider social/environmental impacts as well as private economic costs and benefits so that externalities are incorporated into the decision process. In this way, Cost-Benefit Analysis can be used to estimate the social welfare effects of an investment 3. Time matters: Cost-Benefit Analysis can take account of the economics of time known as discounting. This is important when looking at environmental impacts of a project in the years ahead.

WHAT ARE COSTS AND BENEFITS ?

Benefits are the monetary values of desirable consequences of economic policies and decisions. Together with costs they reflect the changes in individual and social welfare that result from implementing alternative programs. Benefits are generally classified as direct, indirect, and intangible:
y

Direct benefits are the values of desirable health and nonhealth outcomes directly related to the implementation of proposed interventions that can be estimated by using market-based data.

Indirect benefits are the averted costs and savings resulting from the interventions but not related directly to them.

Intangible benefits include the values of positive outcomes (e.g., reductions in health risk, pain, and suffering), which cannot be estimated from market data.

Example : A vaccination program against an infectious disease protects the participants from catching the infection and provides additional "herd immunity" for the population, including unvaccinated persons. These are the program benefits:
y

The savings associated with prevented illness cases among those actually vaccinated would be classified as a direct benefit.

The savings resulting from lower morbidity among unvaccinated persons due to herd immunity would be an indirect benefit.

The reduced risks of catching the infection for those vaccinated and the peace of mind resulting from that risk reduction would be intangible benefits.

Costs are the values of all the resources (e.g., labor, buildings, equipment, and supplies), tangible or intangible, used to produce a good or a service.

In everyday life we generally think of the financial or monetary cost of goods and services we consume. The "price tag" is what we refer to at the store. It is a convenient measure of cost: all the resources have readily available prices, and exchanges are based on monetary value.

Economists think of costs as consequences of choices. In the real world, resources are scarce. Because resources are limited, all necessary interventions cannot be implemented. When decisionmakers choose to implement a program, the resources expended will not be available for other possible uses.

For instance, the decision to allocate funds for a public health program renders these funds unavailable for education, housing, or defense spending.

Therefore, the true cost of a program is not just the amount of funds spent on it. It is also the value of benefits that would have been derived if the resources had been allocated to their next best use. Economists call it the opportunity cost of a resource or program

STEPS OF COST BENEFIT ANALYSIS

STRENGTHS AND LIMITATION OF COST BENEFIT ANALYSIS

Strengths Compares costs and benefits using equal terms Provides a clear indication of net cost or benefit of a specific area or regulation, helping justify decisions at various levels
o o o

o o

Simplifies complex concepts and processes Accepted by society more readily than other economic methods Can be carried out at many levels (i.e., local, regional, national, international)

Limitations Can be difficult to determine accurately the discount rate of future costs and benefits, as well as indirect impacts
o

Often require non-market value methods with varying degrees of complexity and accuracy

o o o

Costs are easier to estimate than benefits Can be a time-consuming and expensive process Does not always consider the source of the costs and benefits, needs to consider factors such as environmental justice and indirect impacts

Does not usually consider questions of environmental justice and how costs and benefits are distributed across different groups

DISADVANTAGES OF COST BENEFIT ANALYSIS

1. Potential Inaccuracies in Identifying and Quantifying Costs and Benefits 2. Increased Subjectivity for Intangible Costs and Benefits 3. Inaccurate Calculations of Present Value Resulting in Misleading Analyses 4. A Cost Benefit Analysis Might Turn in to a Project Budget

EXAMPLE OF COST BENEFIT ANALYSIS

Example: A sales director is deciding whether to implement a new computer-based contact management and sales processing system. His department has only a few computers, and his salespeople are not computer literate. He is aware that computerized sales forces are able to contact more customers and give a higher quality of reliability and service to those customers. They are more able to meet commitments, and can work more efficiently with fulfillment and delivery staff. His financial cost/benefit analysis is shown below: Costs: New computer equipment:
y y y y y

10 network-ready PCs with supporting software @ $2,450 each 1 server @ $3,500 3 printers @ $1,200 each Cabling & Installation @ $4,600 Sales Support Software @ $15,000

Training costs:
y y y

Computer introduction 8 people @ $400 each Keyboard skills 8 people @ $400 each Sales Support System 12 people @ $700 each

Other costs:
y y y

Lost time: 40 man days @ $200 / day Lost sales through disruption: estimate: $20,000 Lost sales through inefficiency during first months: estimate: $20,000

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Total cost: $114,000 Benefits:

y y y y y y

Tripling of mail shot capacity: estimate: $40,000 / year Ability to sustain telesales campaigns: estimate: $20,000 / year Improved efficiency and reliability of follow-up: estimate: $50,000 / year Improved customer service and retention: estimate: $30,000 / year Improved accuracy of customer information: estimate: $10,000 / year More ability to manage sales effort: $30,000 / year

Total Benefit: $180,000/year Payback time: $114,000 / $180,000 = 0.63 of a year = approx. 8 months

Tip: The payback time is often known as the break even point. Sometimes this is is more important than the overall benefit a project can deliver, for example because the organization has had to borrow to fund a new piece of machinery. The break even point can be found graphically by plotting costs and income on a graph of output quantity against $. Break even occurs at the point the two lines cross. Inevitably the estimates of the benefit given by the new system are quite subjective. Despite this, the Sales Director is very likely to introduce it, given the short payback time.

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CONCLUSION

Cost-benefit analysis can nevertheless serve as a useful tool in alternatives evaluation. It can be used to assess overall benefits, to compare the relative magnitude of specific costs and benefits, and to assist in prioritizing among alternatives. Moreover, performing a Cost Benefit Analysis is critical to the continuation of a development product. Superficial attention to its development may result in erroneous conclusions which will lead a company down a path to disaster. It is important that both costs and benefits be thoroughly defined and scrutinized.

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REFERENCES

 http://www.brighthub.com/office/project-management/articles/58627.aspx  http://www.cdc.gov/owcd/eet/CBA/fixed/TOC.html  http://management.about.com/cs/money/a/CostBenefit_2.htm  http://it.toolbox.com/blogs/enterprise-solutions/doing-cost-benefit-analysis-part-113037

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