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Cost-benefit analysis is a sequence of steps a company takes to contrast its costs and benefits in a particular managerial decision, scheme or product. Management compares all the available alternatives that the company has as a way to eliminate bias in choosing from among various options. The investments in the choice and the probable returns at the end of a stipulated period are carefully studied in order to make a decision. A cost-benefit matrix represents this study in the form of a matrix. There are several steps in preparing the matrix.
Define your company’s goals and objectives for a particular project. A cost-benefit analysis breaks down the project’s immediate ends and objectives. A brief write-up is also provided as project notes. This way, everyone who reads it knows what the company plans to accomplish with the project.
Develop alternative plans and schemes for accomplishing the goals of your project. Gather data on the costs associated with each alternative and consider the means of procuring the finances for each option. You need to estimate the cash requirements at each stage and work out the total costs for each alternative.
Calculate the benefits of choosing each alternative. One choice may cost the company $200,000 more than another choice but in the end the increase in profits may be $500,000 more with this choice. Contrast the benefits and the investment needed in each choice. Use modelling and simulation techniques to gather data on the future benefits the company will receive from each alternative. It helps to rank each alternative according to the costs and benefits.
Represent the cost-benefit analysis in the form of a matrix. On the "X Axis," plot the costs and on the "Y Axis" plot the benefits. Calculate a median point for both the costs and the benefits. For example, if costs range between $0 and $2,000,000, the median point would be $1,000,000. Costs below 1,000,000 would be termed as low and costs over and above $1,000,000 would be classified as high.
Use a software application for drawing out your cost-benefit matrix. Many companies benefit immensely by using a software model. The application determines the future values of the costs and the returns and then provides recommendations on the best possible choice the company has.
Indrajit Dutta holds a Master of Business Administration in finance and strategy. She has been writing professionally for more than 10 years, specializing in management, finance and human resources.