Cost-Benefit Analysis in Project Management

Fahad Usmani, PMP September 3, 2022

Today we will discuss cost-benefit analysis in project management. This technique is also known as benefit-cost analysis, cost-benefit ratio, project cost
analysis, etc.

It is rare for an organization to have unlimited resources, so they routinely must choose the best option from all the opportunities available. One of the
ways organizations make these decisions is by using cost-benefit analysis.

This technique is also very helpful when deciding on a new course of action.

Cost-benefit analysis has a vast scope, and explaining it in one blog post is not easy, so I will provide a preliminary outline of this project’s cost analysis
technique.

Cost-Benefit Analysis
Cost-benefit analysis is a benefit measurement method usually performed by top management.

This technique is useful during the feasibility study to determine if the project is worth taking.

Also, cost-benefit analysis helps management select the right project from multiple options during the project selection analysis. They gather data,
analyze all the projects, and then try to discover which project is more profitable.

Cost-benefit analysis provides valuable information, such as:

Expected Profit
Time value of the profit
The basis for comparing the projects

Expected Profit
The cost-benefit analysis finds and converts the benefits into monetary values. Then, the investment costs are subtracted from the benefits to get the
result.

You can proceed if the result is positive; if not, abandon the idea.

For instance, suppose your company is involved with manual bookbinding, and you propose that management buy equipment to improve efficiency.

Before submitting the proposal, you will perform a cost-benefit analysis. You will list the costs of the investment.

For example:

Machine cost
Maintenance cost
Cost of electricity used by these machines
Then you will identify the benefits, such as

Profit from improved production

Cost of reduced workforce
Cost of the better-quality product

You will figure out the investment cost and the monetary value of the benefits.

You will then perform the cost-benefit analysis by subtracting investment cost from the benefits. Use this figure with management to justify your
proposal.

Time Value of the Profit

In cost-benefit analysis, you calculate the expenditure and the expected profit. Remember that profit earned after several years will not have the same
value as today, so consider inflation while analyzing the cost. Inflation erodes the value of money, so your profits won’t go as far.

For example, assume a 5% inflation yearly. What you can buy for 100 USD today will cost 105 USD after one year.

Calculating the Current Worth

Assume that you invest 100,000 USD in a project. You expect to earn a 10,000 USD profit after one year.

Considering yearly inflation of 5%, what will the current value be?

The formula to find the Current Value is

FV = CV(1+r/100)^n

Here,

FV = Future Value

CV = Current Value

r = Inflation

n = time

Given values,

FV = 10,000 USD

r=5

n =1

Putting these values in the formula,

10,000 = CV(1+0.05)^1

CV = 10,000/1.05

CV = 9,523.80

Therefore, the current value of your profit is 9,523.80 USD.

There is no specific cost-benefit analysis formula; however, simple equations can provide accurate information.

The Basis to Compare the Projects

Cost-benefit analysis helps you select the best project when faced with many options. Here you compare the profit earned from each project in current
values and choose the one with the highest profit.

If it is a multi-year project, you will not realize a profit in today’s value. You may hope you will profit from it; however, a Net Present Value (NPV) analysis
could be eye-opening and worth doing.

The Advantages of Cost-Benefit Analysis

Cost-benefit analysis has many advantages. It helps organizations conduct feasibility studies and select prudently from many choices. It is also useful
when an organization takes a new course of action. This analysis has several basic advantages:
 1. It justifies selecting a project.
2. It helps to compare the cost invested and benefits.
3. It provides a baseline for comparing available options.
4. It compares future earnings with today’s dollar value.
5. It helps select the most profitable project.

Limitations of Cost-Benefit Analysis

The benefit-cost analysis has a few limitations.

It is useful for small projects with shorter durations. As the duration increases, this technique gets more complex and unwieldy. Bigger projects are more
difficult; converting intangible costs is not easy, so this technique is no longer useful.

As the project grows more complex, intangible costs and benefits rise. Converting these costs and benefits into monetary form is not an easy task.
Inflation plays an important role in longer projects. Also, the greater the project duration, the greater the risks.

Summary
The cost-benefit technique is a systematic approach to calculate the investment cost and received benefits. It is a simple technique that lets you know if
you should proceed with the project or which project you should select among many.

Cost-benefit analysis is an important concept from a PMP exam point of view. Make sure you fully understand it.

How do you use cost-benefit analysis in your organization? Please share your thoughts in the comments section.

#Benefit Cost Analysis #Cost Benefit Analysis

Fahad Usmani, PMP

I am Mohammad Fahad Usmani, B.E. PMP, PMI-RMP. I have been blogging on project management topics since 2011. To date,
thousands of professionals have passed the PMP exam using my resources.
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22 Comments

Joke Adeyemi says:

June 9, 2023 at 4:33 AM

Please permit me to ask few questions here. Before I get confused. Shortly before I came across your blog, I have learnt that Cost benefit analysis also known as
Return on Investment (ROI) can be calculated using this formula: (G-C)/C=ROI.

However, you gave FV=CV(1+r/100)^n as the formula for calculating the Future value of a project/current worth.

The question is looking at the two formulae above, one tends to measure ROI in percentage while the other, the current worth.

During an examination, how can we know which of the formulae to use?

Thank you

Reply

Awhe says:
September 15, 2023 at 2:10 PM

Cost/Benefit analysis is conducted in steps. Step one is the calculate the cost and benefits in today or current prices. That is,
the incremental gains G (or benefits) minus the incremental costs C divided by the costs C {(G-C)/C} to estimate the Return on Investment (ROI) The rule of
thumb is that a project that gives a positive ROI is acceptable. +ROI means that for every unit of currency expended, you are receiving a higher sum in return.
 However the formula {(G-C)/C} is a simplified statement of the true picture of project inflows and outflows, which come at different times in the life of the
project. There is need to account for the time value of money. A unit of inflow or outflow today is rated more than the flows a year or more from now. Future
flows or values (FV) are discounted at a given discount rate (r) to give a their current values (CV) to arrive at a Net Present Value (NPV). A project with a
positive NPV is acceptable. The discount rate (r) at which the NPV=0 is called the Internal Rate of Return (IRR). A project is acceptable if the IRR is more than
the ongoing savings interest rate. What that means is that, all things being equal, it is better to invest your money in a project than put it in the bank, and vice
versa.

Simply, use the (G-C)/C formula to illustrate project cost/benefit analysis without consideration of the time value of money.

Reply

Mousham says:
May 21, 2023 at 7:29 AM

Thank you, it was very helpful to learn how intangible costs and inflation impact the overall CBA.

Reply

Erfan Yahyapour says:

May 10, 2023 at 3:33 PM

I’m commenting on this one:

“There is no specific cost-benefit analysis formula; however, simple equations can provide accurate information.”

There is actually! The ‘Engineering Economics’ provides pre-defined different types of solutions on how to calculate net value, whether it is present to annual,
future to present, etc. The equations and calculations are pretty simple to follow and implement. I recommend everyone reading this to watch some videos on
Youtube about this interesting discipline.

Thanks a lot Fahad for the great content.

Reply

Ivy Uduakobong says:

March 10, 2023 at 3:32 PM

Thank you. It was well put out, which encouraged ease in assimilation for me.

Reply

Pat Podchara P. says:

November 15, 2022 at 7:30 AM

Thank you for sharing. It is really helpful for me as a project manager.

Reply

Andrew Ushie says:

September 11, 2022 at 10:43 AM

How do you quantify intangible benefits? are there standard procedures to do that?

Reply

Rafik Siabdellah says:

July 27, 2022 at 3:39 PM

Thank you for the valuable information, you’ve done great job by helping people, this our Mission as a human.
Thank you again
.

Reply

Tabitha Ndung'u says:

July 27, 2022 at 12:03 PM

This blog has taught me so much. I am a newbie learning project management to hone my skills.

Reply

Armin Christopher E. Cuadra says:

July 11, 2022 at 1:41 AM

Thanks, Fahad. You made this very easy to understand.

Reply

Thakur says:
June 12, 2022 at 3:17 PM

you are doing good work bro.. thank you

Reply

fredrick says:
June 7, 2022 at 3:35 AM

thank you great blog!!!

Reply

Dineo says:
December 14, 2021 at 3:04 PM

I am an newbee in the field… still studying. How I do appreciate that analyzing the budget for a project prior to beginning it is an important part of the
foundation we call project initiation.

Reply

Abdelbaky says:
April 26, 2021 at 12:03 AM

Analyzing the expected cost and profits is a good strategy in all cases, provided that it is undertaken before the start of the implementation of the project to
determine the extent of its economic feasibility for the company in addition to anticipating the general economic situation and making an account for the
economic, technological and political market grades

Reply

SD says:
June 20, 2017 at 3:54 PM

Does this technique is performed outside of the project boundaries by senior management to determine if they should proceed with the project or terminate??

How can we say that benefit/cost analysis is done in initiation phase??? Because in initiation phase, we already get the selected project for which charter is
developed.

Reply

Fahad Usmani says:

June 22, 2017 at 10:23 AM

This analysis is performed by the project sponser to see if it fulfills his objective.

Initiation phase and Initiation process groups are different. What you are talking is, initiation process group, not initiation phase.

Reply

Tauseef Qureshey says:

December 2, 2014 at 12:12 AM

How we can convert Benefit Cost Analysis into Monetary value or funds or money before submitting our proposal or project to the management?

Reply

Fahad Usmani says:

December 2, 2014 at 10:35 PM

Hello Tauseef, please refer below blog post:

https://pmstudycircle.com/2014/03/project-selection-methods/
 Reply

Fahad Usmani says:

December 1, 2014 at 12:28 PM

Cost benefit analysis is performed during Initiating process group. I believe it falls under project integration management knowledge area.

Reply

Tauseef Qureshey says:

November 29, 2014 at 11:46 PM

Cost Benefit Analysis belongs to which process knowledge area

Thanks

Reply

Ajay Bagati says:

September 6, 2013 at 7:25 AM

Nice & simple blog. Thank u Fahad.

Reply

Fahad Usmani says:

September 7, 2013 at 6:50 PM

Thanks Ajay for your comments. See you again…

Reply

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