Mastering Cost-Benefit Analysis: A CFO’s Perspective

Cost-benefit analysis (CBA) is a process that weighs the advantages of a course of business action against potential costs. Performing a cost-benefit assessment gives businesses a framework to evaluate choices, guiding them to proceed with the most profitable actions and avoid costly ones.

Often used by government agencies to demonstrate fiscal responsibility, cost-benefit analysis is also an important tool for businesses. Companies can use CBA to evaluate the consequences of major decisions, manage risk and drive effective decision-making. During economically volatile periods, smart businesses factor CBA into their overall financial strategy.

The Key Components Of Cost-Benefit Analysis

According to a CFO in the Paro expert network, cost-benefit analysis helps break down the potential cost and risk of every action into concrete terms and categories, allowing for flexible, realistic budgets. Consider an expanding business trying to choose between renting additional manufacturing capability or acquiring their own facility. CBA helps the company analyze the following:

• Direct costs: Direct costs include initial fees such as land purchase, construction costs and staffing expenses, as well as known operating costs.
• Indirect costs: These are fixed costs like utility charges for the new facility, which may not be fully known until after completion but can be estimated with reasonable accuracy.
• Intangible costs: These are qualitative costs that may include impact on employee productivity and morale or potential boost to brand image. Intangible costs also include opportunity costs—the lost value of actions not undertaken because the analyzed action absorbs the resources instead.

A full CBA also assesses the action’s potential benefits by similar metrics:

• Direct benefits: Increased production and revenue provided by the new facility. 
• Indirect benefits: A more efficient distribution chain going forward.
• Intangible benefits: Increased customer satisfaction, improved brand image, being the first to market, etc. 

Conducting an Effective Cost-Benefit Analysis

Cost-benefit analysis is generally reserved for larger decisions, as the process takes time and skill. There is more to each major choice than just the upfront price; CBA assigns a dollar value to every pro and con, and the calculations can become complex. But CBA is available to businesses at all stages, whether just starting up or firmly established. 

One Paro expert and fractional CFO successfully used cost-benefit analysis to secure funding for the implementation of a new feature in a company’s product, illustrating the method’s practical impact. The assessment clearly demonstrated that the new feature would drive significant revenue. Investors agreed and released additional funding, resulting in more signed deals and increased market share.

Keep reading to learn more about the strategic value of cost-benefit analysis, including communicating results to stakeholders, and common pitfalls to avoid.

Enjoyed this article? Subscribe to our newsletter to get the latest articles, news and resources from Paro.

#futureoffinance #financialanalysis #cfo #financetransformation