How to Calculate Net Benefits

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How to Calculate Net Benefits
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Net benefits are commonly used in cost-benefit analysis to determine whether a project should be funded. Calculate net benefits by subtracting the sum of direct and indirect costs from the sum of direct and indirect benefits. Costs and benefits are expressed in equivalent measures so that investors can see whether the benefits would outweigh the costs enough to make pursuing the project worthwhile.

Calculate Benefits

Identify all benefits that the project would produce. This includes direct and indirect benefits. Direct benefits can be attributed directly to a project, such as the specific items that a new piece of equipment would produce. Indirect benefits are derived from a project, like the overtime dollars that a company would not have to pay because it could produce more items in less time. Add direct benefits to indirect benefits to get total benefits.

Calculate Costs

List all costs that are associated with a project, including direct and indirect costs. As with benefits, direct costs are those that are tied directly to a project, like the costs of purchasing a new piece of equipment. Indirect costs would be incurred as a result of the project, such as the need for maintenance supplies and services. Add direct costs and indirect costs to get total costs.

Choose an Equivalent Measure

Benefits and costs may be measured differently, as units of time, input, output or money. But a common measure must be used in a cost-benefit analysis. For example, time must be converted to money. If a worker will spend eight hours operating a machine, then the amount of wages that worker earned based on his or her hourly rate may be compared to the dollar value of the items that the machine would produce in the same time.

Account for Time

A benefit reaped today is not equal to a benefit that is projected, though not necessarily guaranteed, to come. Nor is a dollar today worth the same as a dollar tomorrow. In a cost-benefit analysis, total benefits and total costs are multiplied by a discount factor. Commonly used discount factors include the interest rate paid to borrow capital for a project and the rate of return that could be realized if those same funds were invested for the equivalent time. The discount factor addresses the risk and uncertainty of deferred benefits and future costs for a project, so that a more informed decision on whether to proceed can be made.

Calculate Net Benefits

Subtracting the total costs from the total benefits in an equivalent measure after accounting for the effects of time results in the net benefits. If the net benefits of a project exceed its costs, then investors might decide to proceed. They may also compare net benefits of competing projects to choose which to pursue.

References

About the Author

Jim Molis has more than 20 years of experience writing for and about businesses. He has been a business reporter for the Columbus (Ga.) Ledger-Enquirer, a managing editor of the Atlanta Business Chronicle and an editor of the Jacksonville Business Journal. He also has written for management consultants, professional services firms and numerous publications as a freelancer.