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Cost Benefit Analysis As a Tool for Decision Making

November 12 2015 , Written by Fanny Pangilinan Published on #Management

Cost Benefit Analysis As a Tool for Decision Making

Cost Benefit Analysis (CBA) is the process of looking at all variables to a desired outcome. It is used to find the most cost effective way to provide a service, asset or commodity to a customer.

CBA Example

Consider replacing an obsolete computer system for your inventory control. Some sample variables would be:

1. Upgrading the current system.
2. Purchasing a new computer.
3. Out sourcing the task to another company.

Cost Variables

What is the total cost to upgrade what is currently available? Will it last as long as a new system? Will it be supportable for as long as a new system would last?

If a business purchases a new computer, will it run on their existing software? Will they need to purchase new software? What will it cost to transfer old data to the new system? Would staff require training on the new system and perhaps new software?

What will it cost to send work out to a different company to do the same thing?

When looking at upgrading, compare the costs associated with the upgrade as opposed to a new system or out sourcing the work.

Comparing Options

Compare all three options. Look at cost, time involved and expected result. In most cases this can be done very simply in house by simple comparison. For larger projects there is software available to make the comparisons for a business.

What is gained by each of the three options? Sometimes an option may be more costly to implement but total life cycle costs for that option may be less over the proposed life of the system. What may seem the cheapest at first may not be best in the long run.

This is a simple example but it can be done across a full spectrum of options. If a project is a large one that seems impossible, break it down into manageable sections and do them one section at a time. Add the totals and compare the outcome of each.

An Actual Case Study

A Tracking Radar had an obsolete computer operating on DOS. It was decided to replace the computer to take advantage of newer operating systems. The cost for the new computer was negligible. However, when it came to making the new computer compatible with the older DOS based software, it was discovered the software needed to be upgraded to work with the new computer.

The computer cost less than one thousand dollars. The cost to upgrade the software to work with a new operating system was in the hundreds of thousands of dollars. What at first appeared to be a simple remove and replace ended up costing over a hundred thousand dollars.

Upgrading of the old computer with a faster motherboard, memory, speed and spares to help keep the old computer operational for the next five years was shown to be less than fifteen thousand dollars.

In this case, it seems the second option was best based on cost alone. When the benefit of having updated software using new technology was considered, the first option was chosen. Over the projected life of the system, it was deemed best to spend the funds for long term gain and speed. Another consideration was depreciation. The older system was fully depreciated and had no further tax value for keeping it. The newer system was fully depreciable and even though its initial cost was higher, the choice was the best option.

Consider all your Options

When all options were evaluated the obvious choice was determined. Take the time to look at the options. What appears at first to be the most logical may often not be the case after full evaluation.

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