Analyze The Cash Flow Problems A Business Might Experience The 10 Most Asked Questions of Cost Benefit Analysis

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The 10 Most Asked Questions of Cost Benefit Analysis

It is very important to follow proven principles when making decisions using cost benefit techniques. Your company’s health and your reputation depend on it. If you don’t follow these rules, your decisions may go wrong.

Let’s get started shall we?

Question 1. Is this technique suitable for a small business owner?

yes The theory works for big business and small business as well as government.

Cost benefit analysis is a decision-making technique that evaluates the positive outcomes (benefits) as well as the negative outcomes (costs) of various decision alternatives. The trick is to simplify its implementation for small businesses.

Once you have a basic understanding of the theory and can enter data into a spreadsheet, the rest is not too difficult.

Question number 2. Is that all I need to make good decisions?

No. Cost Benefit Analysis is a tool that helps in making good financial decisions. It is not an end in itself. However, part of the cost benefit process is that you must consider all options broadly before making a final decision. Most people fail in their decision-making efforts.

Cost benefit analysis is also very adept at providing a single feasibility output for each competing alternative, making comparisons objective and easy.

Question #3. What do I include as costs and benefits?

costs. All costs attributable to the project will be included. Some of these are listed below:

– Asset costs (both capital and running)

– Cost of supplies for purchased items

– Additional administrative effort required to manage the project

– Delivery charges if in your account

– Transfer of assets in future years

– Cost of tender preparation

– Any special tooling related to the project

revenue. Revenue can be attributed only if the project should not have proceeded if it had not been received.

Asset disposal and residual values. Some assets may be retired before the end of their useful life or saved at the end of the project. This value should be included in cash flows (less costs associated with their sale or disposal).

Cost savings. All cost savings attributable to the project will be included. Wage and salary cost savings must include their overhead and on-costs.

Question #4. How do I handle non-financial costs and benefits?

Since the cost benefit model involves only cash transactions (both costs and benefits), non-monetary costs and benefits are usually described through notes.

If the benefit cost ratio = to 1 or > 1 then it is not necessary to use non-financial costs and benefits as the project is already feasible. Typically these non-financial costs and benefits will be included when comparing competing alternatives that have close benefit cost ratios.

Question #5. How can I test my hypothesis?

You are in the best position to make assumptions based on your own experience and judgment. However, you can use a technique to show others how strong your assumptions really are. This technique is called sensitivity analysis.

Understanding this technique is important because you make many assumptions in your analysis. This could be, for example, the level of new income, the savings generated or the residual value of the asset at the end of the project’s life. These assumptions are at the heart of your analysis and contribute to your final benefit cost ratio results.

Since the future cannot be accurately predicted, there is a high chance that some of your assumptions will be wrong.

Using this technique will add conviction and weight to your proposal by showing how changes in costs and benefits affect the benefit cost ratio. Do small changes move the project from VIABLE to UNVIABLE?

Question #6. How can I be sure the project is viable?

You have built your hypothesis based on your project knowledge and experience. You have created a model that shows the project is feasible. If you follow proven principles, that’s fine. Once the project is authorized, it is important to ensure that the assumptions are correct and actually deliverable.

Follow these items to ensure that:

– Any labor savings must be delivered – Redeploy affected resources

– Cost savings from process changes need to be acted upon quickly

– Increased revenue due to price hikes must be implemented immediately

A post-completion review within a year of project implementation will show you whether all or some of your assumptions were correct. It will also teach lessons on how to do it more successfully than making the same mistakes again next time.

Question #7. How can I implement this technique in my company?

There are several ways as follows:

– Use cost benefit analysis yourself in pilot projects

– Convince the CEO of the company’s benefits and exercise that authority

– Use cost benefit analysis in specific business units

All these ways require a thorough understanding of the theory, the reasons for its implementation and the expected payoff.

A training program must be undertaken so that all participants understand the technique.

Question #8. Why must NPV be included in accounting for the time value of money?

Usually the life of the asset, or the financial impact of the decision taken, is more than 1 year. This is usually 3 – 5 years (computers, software, factory machinery), 20 years for some large electrical equipment and up to 100 years for underground pipes used in water and sewer networks.

Inflation, over the years, reduces the purchasing power of the dollar causing us to spend more in dollars each year to buy the same goods. So projects whose life span is more than one year.

Costs and benefits incurred in year 3 or 4 of the project will not be affected as much as they were in year 1.

If NPV is not used in the model then the final judgment about benefit cost ratio and feasibility may be completely wrong.

Question #9. Are there any limitations to its applicability?

Not really, unless you’re dealing with financial costs and benefits. It applies to decisions large and small, complex and simple, long-lived and short-lived assets, profit-based and government and charitable organizations. Some common limitations are:

Subjectivity – It is unlikely that two analysts working independently will estimate the exact same cost benefit ratio number. There are several variables that can be handled slightly differently, some of which are listed below:

– Estimation of the physical and/or financial life of the asset/project

– Estimation of costs/benefits of environmental protection

– Selection of discount rates (rates described above are indicative of the range that may apply)

– Value of benefits may be different for different groups in society (i.e. the value of $ is different for the poorer section of the society than for the richer section)

Political decision-making – The need for political decision-making on project feasibility (timing of elections, territorial allegiance) can influence outcomes. Also the decision makers are not homogeneous in space and time.

First Round Effects – We will generally only include those effects that directly contribute to the project moving forward. For example, a project that goes ahead will not increase community agricultural production. This will only be justified if the sector is inherently less employable.

Question No. 10 How can this technique actually help me?

There are several ways – some are listed below:

– Knowing you’ve used a proven reliable method boosts your confidence.

– After considering all options to solve the problem, you can present your proposal knowing you have the answers.

– Using this technique will ensure you get more opportunities for recognition and advancement

– Once the company sees the benefits of this technique it may want you to coach other employees or become an implementation champion – more opportunities for you.

– This technique will save you time in project evaluation and ranking of competing proposals.

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