Cost-benefit analysis

What it means

Cost-benefit analysis compares everything a project or decision will cost with everything it will bring, in money and over time. Adding up costs and revenue is not enough: money arriving in five years is worth less today, so future flows are converted using a discount rate.

The result is usually several indicators. Net present value shows how much value the project creates in today’s money, the internal rate of return its yield and the payback period when the money invested comes back. If NPV is positive, the project pays off on the given assumptions.

Benefits that are hard to measure, such as time saved, fewer errors or customer satisfaction, are included too. They are either estimated in money or described alongside the figures so they are not forgotten when deciding.

How it works in practice

In EU-funded projects a cost-benefit analysis is often a mandatory part of the application, and the managing authority has a methodology for it. For company investments we prepare one, for example, when buying a machine, switching to new software or choosing between buying and leasing.

We include costs in full, not just the purchase price: installation, training, maintenance, energy, licences and the time of your own people, which is what TCO captures. We estimate benefits cautiously and from data the company has, such as the hours spent today on manual processing.

We always add a sensitivity analysis to the result: what happens if the benefits are a third lower or the project is six months late. A decision that pays off only in the most optimistic scenario is a bet, not an investment.

What to watch out for

The most common mistakes are optimism about benefits and forgotten costs. Software meant to save two people often saves one and takes another year of effort to roll out. If the analysis is prepared by whoever champions the project, have someone independent check it.

The second is ignoring opportunity cost: the money and people used on this project cannot do something else. Always compare against an alternative, including doing nothing, which has its own costs as well.