Cost Benefit Analysis

The goal of cost benefits analysis is to compare the costs of implementing a solution with the monetary benefits expected from the solution.

Costs of an implementation may include:

• Software purchase or development
• Equipment purchase
• Building development or innovation
• Additional labor or hiring
• Training expenses
• Additional supplies
• Losses associated with disruption due to the implementation

Benefits of an implementation may include:

• Increase in product margin
• Increase in revenue
• Cost savings
• Increase in staff morale (intangible)
• Increase in customer retention (intangible)

Return on Investment (ROI)

The Return on Investment (ROI) provides a rough estimate on how soon the money invested on the improvement would be paid back.

Besides the obvious monetary benefits like increase in revenue/profit, cost savings; the factors like increase in customer or mitigation of customer loss etc. should be considered as contributing to benefits each year.

The formula to calculate the Return on Investment (ROI) is:

(Cost of implementing solution) / (Annual financial benefits – annual costs)

For example,

If a project cost $90,000 to implement and $5000 per year in extra labor, and the team expects around $35,000 financial benefits each year,

ROI = $90,000 / ($35,000 – $5,000) = 3 years

Net Present Value

A more accurate way to calculate the cost benefits is known as Net Present Value (NPV). NPV adjusts benefits and costs as time passes because the cashflow in the future is not as valuable as current cashflow due to inflation and other economic factors.

In the example above, if the same is to be calculated based on the NPV for the 3 years after the implementation, the result would be:

It shows a -$8,302.56 NPV as compared to the ROI calculation method