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COST / BENEFIT ANALYSIS
Data gathering is only one part of systems analysis. The next steps are to examine the data, assess the situation, look at the alternatives, and recommend a candidate system, The costs and benefits of each alternative guide the selection of one alternative over the others. Each approach has costs and benefits that are compared with those of other approaches before a final recommendation is made. The outcome is a system proposal (also called a project proposal) that summarizes the findings of the analysis and states the recommendations for design.
DATA ANALYSIS .
Analysis of the data collected made it obvious that customers were frequently billed too late. Consequently. too often. System investigation and data gathering lead to an assessment of current findings. and the cost of making improvements.000 to 8. For example the safe deposit department was authorized to double its capacity from 4. or not at all. Our interest is in determining how efficiently certain steps are performed. .DATA ANALYSIS Data analysis is a prerequisite to cost/benefit analysis. the number of employees changed from three to five. with one employee assigned full-time to billing.000 boxes in an effort to meet increased demand. how they contribute to achieving the intended goals.
detail) Heaviest activity on Fridays and before holidays Too many steps taken with new customers Delay in billing³all manual Some 80 renewal payment notices prepared daily Cash received given to head teller at end of each day Poorly designed application forms Accounting gets daily summary Procedure for customer access to boxes is neither documented nor consistent .DATA ANALYSIS « Analysis Current System Facts Objectives (System Design Requirements) Better customer service Faster information retrieval Quicker notice preparation Better billing accuracy Lower processing and operating cost Improved staff efficiency More consistent billing procedures to eliminate errors What is done? Open customer account Assign safe (processes) deposit box Issue key Receive annual rent How is it Some 40 boxes opened or closed daily Master done? card file located too far from customer inquiry (processing station.
DATA ANALYSIS « Analysis Who does it? (personnel) Current System Facts One person handles billing (full-time) One person handles security Three persons process customers into and out of safe deposit area Except for two persons. box number.5 minutes 15 percent of billing is erroneous in amount. rest of staff is poorly trained Communication among staff is adequate Location allows privacy and security Billing carried out close to customer counter Objectives (System Design Requirements) Better trained personnel Experience in computer use for other applications Where is it done? (physical location facility) Assessment of Time to prepare a renewal notice is 10 minutes processing Time to process a customer is 3.000 for mailing Employee payroll is as high as junior officers in operations area Allocate quiet space for computer Provide security measure for information access . or amount of rent 28 percent of vacant boxes cannot be located on existing books Frequent notices regarding "to be renewed" boxes cost $8.
These features must be incorporated into a candidate system to produce the necessary improvements. .DATA ANALYSIS « The system profile summarizes the operating characteristics of the safe deposit system. Better billing accuracy. such as the volume of work. Improved staff efficiency. The system requirements are: Better customer service. and personnel. the system design requirements are identified. Quicker notice preparation. Faster information retrieval. nature of processes. Consistent billing procedure to eliminate errors. Lower processing and operating costs. From the analysis. physical facilities.
The analyst then selects those that are feasible economically. The approach may emphasize the introduction of a computerized billing system. . technically. or a combination of several options. several alternatives must be evaluated. improved billing practices. changes in operating procedures. replacement of staff. and operationally.DATA ANALYSIS « To achieve these design objectives.
COST / BENEFIT ANALYSIS .
COST / BENEFIT CATAGORIES In developing cost estimates for a system. we need to consider several cost elements. . Among them are Hardware Personnel Facility Operating Supply costs.
printer. In some cases. disk drive. tape unit). the best way to control for this cost is to treat it as an operating cost. .COST / BENEFIT CATAGORIES HARDWARE COSTS Hardware costs relate to the actual purchase or lease of the computer and peripherals (for example. Determining the actual cost of hardware is generally more difficult when the system is shared by various users than for a dedicated stand-alone system.
Costs incurred during the development of a system are one-time costs and are labeled developmental costs. the costs of operating and maintaining the system become recurring costs. .) as well as pay for those involved in developing the system. Once the system is installed. etc.COST / BENEFIT CATAGORIES PERSONNEL COSTS Personnel costs include staff salaries and benefits (health insurance. vacation time. sick pay.
and air conditioning.COST / BENEFIT CATAGORIES FACILITY COSTS Facility costs are expenses incurred in the preparation of the physical site where the application or the computer will be in operation. These costs are treated as one-time costs and are incorporated into the overall cost estimate of the candidate system. . lighting. flooring. This includes wiring.
. the amount depends on the number of shifts. One approach is to treat operating costs as overhead. and the category of the operating staff. The amount charged is based on computer time.COST / BENEFIT CATAGORIES OPERATING COSTS Operating costs include all costs associated with the day-to-day operation of the system. In any case. staff time. There are various ways of covering operating costs. and volume of the output produced. some accounting is necessary to determine how operating costs should be handled. the nature of the applications.
COST / BENEFIT CATAGORIES SUPPLY COSTS Supply costs are variable costs that increase with increased use of paper. ribbons. . They should be estimated and included in the overall cost of the system. disks. and the like.
PROCEDURE FOR COST / BENEFIT DETERMINATION .
and rules associated with a system.PROCEDURE FOR COST / BENEFIT DETERMINATION Cost/benefit analysis is a procedure that gives a picture of the various costs. benefits. Take action. 3. . The determination of costs and benefits entails the following steps: 1. Select a method of evaluation. Interpret the results of the analysis. 5. 4. Categorize the various costs and benefits for analysis. Identify the costs and benefits to a given project. 2.
COSTS AND BENEFITS IDENTIFICATION .
such as the price of a hard disk. For example. direct costs. . are easily identified from company invoice payments or canceled checks.Costs and Benefits Identification Certain costs and benefits are more easily identifiable than others.
CLASSIFICATION OF COSTS AND BENEFITS .
. They may be tangible or intangible direct or indirect fixed or variable. Let us review each category.Costs and Benefits Identification The next step in cost and benefit determination is to categorize costs and benefits.
TANGIBLE OR INTANGIBLE COSTS AND BENEFITS .
and employee salaries are examples of tangible costs. em-ployee morale problems caused by a new system or lowered company image is an intangible cost. . Costs that are known to exist but whose financial value cannot be accurately measured are referred to as intangible costs. An outlay of cash for a specific item or activity is referred to as a tangible cost. They are readily identified and measured.Tangible or Intangible Costs and Benefits Tangibility refers to the ease with which costs or benefits can be measured. personnel training. For example. The purchase of hardware or software. They are usually shown as disbursements on the books.
Both tangible and intangible costs and benefits. however. are not easily quantified. Tangible benefits. such as more satisfied customers or an improved corporate image. Intangible benefits. are quantifiable.Tangible or Intangible Costs and Benefits « Benefits are also classified as tangible or intangible. Like costs. . jobs in fewer hours or producing reports with no errors. they are often difficult to specify accurately. such as completing. should be considered in the evaluation process.
DIRECT OR INDIRECT COSTS AND BENEFITS .
Direct or Indirect Costs and Benefits From a cost accounting point of view. Direct costs are those with which a dollar figure can be directly associated in a project. a new system that can handle 25 percent more transactions per day is a direct benefit. They are applied directly to the operation. costs are handled differently depending on whether they are direct or indirect. For example. the purchase of a box of diskettes for $35 is a direct cost because we can associate the diskettes with the dollars expended. For example. Direct benefits also can be specifically attributable to a given project. .
. costs are handled differently depending on whether they are direct or indirect. For example. a new system that can handle 25 percent more transactions per day is a direct benefit. Direct costs are those with which a dollar figure can be directly associated in a project. For example.Direct or Indirect Costs and Benefits « From a cost accounting point of view. They are applied directly to the operation. the purchase of a box of diskettes for $35 is a direct cost because we can associate the diskettes with the dollars expended. Direct benefits also can be specifically attributable to a given project.
and air conditioning are all tangible costs. . but it is difficult to determine the proportion of each attributable to a specific activity such as a report. heat. They are overhead and are allocated among users according to a formula.Direct or Indirect Costs and Benefits « Indirect costs are the results of operations that are not directly associated with a given system or activity. They are often referred to as overhead. it incurs an additional cost. Insurance. maintenance. protection of the computer center. If it increases overhead. A system that reduces overhead realizes a savings. light.
Information about vacant boxes becomes an indirect benefit of the billing even though it is difficult to specify its value. our proposed safe deposit billing system that provides profiles showing vacant boxes by size. will help management decide on how much advertising to do for box rental. and price. For example. location. .Direct or Indirect Costs and Benefits « Indirect benefits are realized as a by-product of another activity or system.
FIXED OR VARIABLE COSTS AND BENEFITS .
and insurance. Once encountered. Examples are straight-line depreciation of hardware. . variable costs are incurred on a regular (weekly.Fixed or Variable Costs and Benefits Fixed costs are constant and do not change. monthly) basis. the costs of computer forms vary in proportion to the amount of processing or the length of the reports required. For example. They are usually proportional to work volume and continue as long as the system is in operation. exempt employee salaries. they will not recur.
consider a safe deposit tracking system that saves 20 minutes preparing customer notices compared with the manual system. For example. Variable benefits.Fixed or Variable Costs and Benefits « Fixed benefits are also constant and do not change. The benefit of personnel savings may recur every month. are realized on a regular basis. An example is a decrease in the number of personnel by 20 percent resulting from the use of a new computer. The amount of time saved varies with the number of notices produced. on the other hand. .
SAVINGS VERSUS COST ADVANTAGES .
Savings versus Cost Advantages Savings are realized when there is some kind of cost advantage. The following table is a summary of savings from the use of a new online teller system. $131.880. the net savings from the online system was $40. . After deducting processing charges of $90. handling charges. and proof machine rental.990. In this installation.870 was saved through a reduction in personnel. So we can say that a true savings reduces or eliminates various costs being incurred.
Reduction in personnel and payroll: Position Collections teller Savings teller Bookkeeper Proof operator Subtotal B.170 6.860 $131.380) Net savings from rentals Total gross savings Less processing charges: Online demand deposit processing Proof of deposit reporting Online savings processing Teller machine rental Total processing charges Net savings/year $33.050 29.400 58.000 5.100 25.880 $18.500) Present units (3 @ $1.840 .990 $ 40.940 10.870 N Average Annual Pay (includes 25 percent benefits) 1 $12. Reduction in proof machine rental: Previous units (4 @ $4.140 13.000 4.230 90.900 Total $ 12.400 5 3 1 10 11.610 9.820 10.Savings versus Cost Advantages A.660 27. Reduction in handling charges C.990 $111.
EVALUATION METHOD .
Cash-flow analysis. The common methods are: Net benefit analysis. Payback analysis. Break-even analysis. Present value analysis. each with pros and cons. Net present value. .Evaluation Method Several evalua-tion methods are available.
NET BENEFIT ANALYSIS .
and easy to present. It is easy to calculate. Today's dollar and tomorrow's dollar are not the same. you'd like to invest less than the $3. .000. The time lag accounts for the time value of money. the amount of investment would be even less. easy to interpret. how much would you be willing to invest? Obviously.000 a year. If you were faced with an opportunity that generates $3. The time value of money is extremely important in evaluation processes. To earn the same money five years from now. What is suggested here is that money has a time value. The main drawback is that it does not account for the time value of money and does not discount future cash flow.Net Benefit Analysis Net benefit analysis simply involves subtracting total costs from total benefits.
000 invested in Treasury notes for three years at 10 percent interest would have a value at maturity of: F = $3.900 $-2.350 Year 2 $-2. $3.000 5. i = Interest rate per compounding period.000 4.000(1 + 0.33) = $3.550 550 The time value of money is usually expressed in the form of interest on the funds invested to realize the future value.10)3 = 3.000 Year 1 $-2.900 $ Total $-5. the formula is: F = Future value of an investment. n = Number of years.Net Benefit Analysis « EXAMPLE Year Cost/Benefit Costs Benefits Net benefits 0 $-1. Assuming compounded interest.000 0 $-1. P = Present value of the investment.993 . For example.000 650 $ -1.000(1.
PRESENT VALUE ANALYSIS .
Present Value Analysis In developing long-term projects. it is often difficult to compare today's costs with the full value of tomorrow's benefits. . present value analysis controls for these problems by calculating the costs and benefits of the system in terms of today's value of the investment and then comparing across alternatives. the time value of money allows for interest rates. inflation and other factors that alter the value of the investment. As we have seen.
The amount is called the present value of the benefit. The amount that we are willing to invest today is determined by the value of the benefits at the end of a given period (year).000 is to be invested in a microcomputer for our safe deposit tracking system. we take the formula for future value .Present Value Analysis « Suppose that $3. The investment has to be made today. We compare present values to future values by I considering the time value of money to be invested. and the average annual benefit is $1. To compute the present value. whereas the benefits are in the future.500 for the fouryear life of the system.
500 invested at 10 percent interest at the end of the fourth year is: .Present Value Analysis « So the present value of $1.
NET PRESENT VALUE .
758.Net Present Value The net present value is equal to discounted benefits minus discounted costs.51. or a net present gain of $1.758.51. The net present value is expressed as a percentage of the investment²in our example: . This value is relatively easy to calculate and accounts for the time value of money. Our $3.000 microcomputer investment yields a cumulative benefit of $4.
PAYBACK ANALYSIS .
though. Like the net profit.Payback Analysis The payback method is a common measure of the relative time value of a project. The payback method is easy to calculate and allows two or more activities to be ranked. it does not allow for the time value of money. the shorter the payback period. It determines the time it takes for the accumulated benefits to equal the initial investment. Obviously. the sooner a profit is realized and the more attractive is the investment. .
Payback Analysis « .
Payback Analysis « .
BREAK-EVEN ANALYSIS .
Break-even is the point where the cost of the candidate system and that of the current one are equal. Unlike the payback method that compares costs and benefits of the candidate system, break-even compares the costs of the current and candidate systems. When a candidate system is developed, initial costs usually exceed those of the current system. This is an investment period. When both costs are equal, it is break-even. Beyond that point, the candidate system provides greater benefit (profit) than the old one²a return period.
Figure 8-6 is a break-even chart comparing the costs of the current and candidate systems. The attributes are processing cost and processing volume. Straight lines are used to show the model's relationships in terms of the variable, fixed, and total costs of the two processing methods and their economic benefits. Intersection B' indicates the point where the total cost of processing 65,000 transactions by the current system is equal to the total cost of using the candidate system. The shaded area beyond that point is the return period. The shaded area AB 'A' is the investment period. Accord-ing to the chart, then, it would be more economical to process manually when volume is below 65,000 transactions during a given time period. Processing volume above B' favors the candidate system.
CASH-FLOW ANALYSIS .
such as those carried out by computer and word processing services.Cash-Flow Analysis Some projects. produce revenues from an investment in computer systems. . Cash-flow analysis keeps track of accumulated costs and revenues on a regular basis.
450 $ 64.840 $ 7.615 29.600 1.565) $17.000 $184.010 5.900 600 2.400 195 12.100 $41.600 2.010 5.400 199 12.845 $47.900 500 2.Cash-Flow Analysis « January Februar y $22.600 $ 7.015 1.906 (29.850 $29.055 1.315 $144.000 March April May June July August September October November December Revenues tram computer service Operating expenses: Facility preparation Hardware lease Insurance Salaries Supplies Telecommunication expenses Travel/entertainment User training Total expenses Cash flow (revenue .000 $27.965 39.400 195 11.300 1.400 195 10.000 $59.040 $ 69.000 7.175 1.730) ($31.740 3.930 $70.175) (12.900 900 2.010 8.900 500 2.445 1.640 1.400 7.640 $ 9.000 1.300 800 2.970) ($43.925 1.795) (1.500 $34.910 $29.300 2.555 19.expense) Accumulated cash flow $26.100 10.225 $ 7.900 400 2.795 1.900 400 2.420 33.075 1.600 4.000 $48.801 11.900 $ 30.050 $ 30.950 1.040 $24.134 .050 $59.760 $27.400 195 12.134 ($29.750 200 3.800 $28.170 $ 7.400 195 12.030 1.685 40.385 1.010 5.400 195 $ 7.885 $ 7.400 195 11.110 $ 7.175) ($41.100 $ 30.805 1.750 700 3.085 22.400 195 12.775) ($43.010 4.010 $66.300 900 2.350 $104.400 195 $ 7.000 $22.010 5.500 $51.100 2.700 $ 71.700 $ 1.400 195 10.850 $28.400 195 12.000 7.410 30.360 $ 7.600 4.850 $28.100 3.805) 45 12.180) ($11.810 $27.
.175. This was the beginning of the payback period. although the accumulated cash flow was $ 43. Operating expenses (including facility preparation) were $51. Revenues for the first month in operation (January) were $22. Break-even occurs at the end of the fourth month (April). The cash flow then was $45.175.Cash-Flow Analysis « The following table illustrates the performance of a new computer service over a one year period.000. facility preparation costs. and the like.730. This was the result of excess expenses over revenues. which resulted in a net expenditure of $29. Accumulated cash flow began to turn positive.
INTERPRET RESULTS OF THE ANALYSIS AND FINAL ACTION .
whenever a choice among alternatives is considered.Interpret Results of the Analysis and Final Action When the evaluation of the project is complete. the results have to be interpreted. In real-life business situations. . cost/benefit analysis is a tool for evaluating projects rather than a replacement of the decision maker. cost/benefit analysis is an important tool.
it has problems: Valuation problems. the costs related to cost/benefit analysis may be on the high side or not enough costs may be considered to do a complete analysis. One is the intentional favoritism of an alternative for politi-cal reasons. . There are two ways of distorting the results of cost/ benefit analysis. then. Furthermore. Occasionally an alternative is overlooked that compromises the quality of the final choice. Intangible costs and benefits are difficult to quantify. a project must have substantial intangible benefits to be accepted. however. the reliability of the final choice is in doubt. Distortion problems. Completeness problems. The second is when data are incomplete or missing from the analysis. In either case. In most cases.Interpret Results of the Analysis and Final Action « Like any tool. and tangible costs are generally more pronounced than tangible benefits.
THE SYSTEM PROPOSAL .
the analyst pre-pares a feasibility report on the major findings and recommendations. At this time.THE SYSTEM PROPOSAL The final decision following cost/benefit analysis is to select the most cost-effective and beneficial system for the user. .
TABLE OF CONTENTS List various parts. and exhibits. highlighting benefits VI. SCOPE Present a brief explanation of the system boundaries IV. COST/BENEFIT STATEMENT List benefits and savings in quantitative terms Present dollar savings versus costs Summarize cost of new equipment. TITLE PAGE Defines the name of the project and who it is for II. showing page numbers III. Quantify net savings and expected returns . SUMMARY/ABSTRACT (optional) Give executive a summary of project. features. STATEMENT OF PROBLEM Describe current system Describe proposed system Indicate how proposed system will solve the problem(s) V. one-time charges.THE SYSTEM PROPOSAL « A written feasibility report should include the following: I. etc.
printers. etc. APPENDIX Include exhibits. CREDITS Give credit to those who contributed to the project study X. IMPLEMENTATION SCHEDULE Submit implementation plan Specify human resources.) List communication equipment (data sets. systems and procedures. Include PERT-CPM or Gantt chart VIII. and other miscellaneous documentation . HARDWARE CONFIGURATION (optional) Lay out computer configuration Describe terminal network and equipment (CRTs. lines.) IX.THE SYSTEM PROPOSAL « VII. requirements. etc. correspondence on project. etc.
Break-even Compares costs of using Easy to understand Does not allow for time factor present and candidate and depreciation value of money systems Cash-flow Revenue minus expense Combines benefits of break-even Ignores time value of money For on a period-by-period and payback methods a limited time period.COMPARISION Evaluation Method Procedure Advantages Limitations Does not account for the time value of money It is only a relative (not absolute) measure of a project's return on investment Net benefit Total benefits minus total Easy to calculate Easy costs to interpret Easy to present Present P = F/[(l + i)n] Easy to calculate F = Future value of an value Equates different investment investment F = P (1 + i)n opportunities with various costs and benefits and discount rates Accounts for time value of money Net present Discounted benefits Relatively easy to calculate value minus discounted costs Accounts for time value of money It is only a relative (not absolute) measure of a project's return on investment Payback Investment divided by Easy to calculate Conservative economic measure yearly savings Compares Has straightforward Applied to one opportunity at a costs and benefits of interpretation for choice between time candi-date system two or more alter-natives for Does not compare profitability of candidate systems multiple investment alter-natives Dos not allow for time value of money. it does not basis take into account the prof-itability of the project Ignores behavioral implications of the numbers in the financial statement .
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