Hand drawing Costs-Benefits graph with black marker isolated on white.
Question 2: Using Cost-Benefit Analysis to Improve Decision Making –
Using Cost-Benefit Analysis to Improve Decision Making
Purpose: Learning how to optimize your resources and improve efficiency is a skill that you can use for the rest of your life. In this discussion, you will identify an opportunity to implement economic decision making using marginal analysis.
Post: What does it mean when economists say you should compare the marginal costs of an action to the marginal benefits? Why wouldn’t you compare the total costs and benefits?
Provide a personal example of something that is usually considered an all or nothing decision and explain how you can break it down into steps to conduct a marginal cost-benefit analysis.
Briefly explain how you would make your decision on when to continue and when to stop in this example.
Importance of Cost Benefit Analysis in Decision Making
Simplifies complex business decisions
A cost benefit analysis template allows businesses to simplify complex business decisions. Companies might entail a variety of expenses in different types of projects at a low level. Performing cost benefit analysis allows companies to measure the benefits of a decision (benefits of taking action minus the costs associated with taking that action). It involves measurable financial metrics such as revenue earned, and costs saved as a result of the decision to pursue a project. This helps businesses to compare different projects based on net benefits irrespective of dissimilarities.
Provides a basis for rational comparison
This is one of the major benefits of performing a cost benefit analysis. With plenty of investments around, companies at times find it difficult to select the best alternative. Businesses who have invested time in projects may be predisposed to pursue those projects despite the availability of financially viable projects. Cost benefit analysis helps businesses to pick through available options, rank projects according to the order of their merit, and overcome biases for the good of the business.
Estimates the net benefit of a project
Predicting benefits is more difficult than predicting costs. Investment opportunities are many but resources at disposal are finite. For instance, a company might estimate the production cost, but it is difficult to predict the profit margins of any new product going on the market. However, estimating costs and benefits can help businesses get an idea of the lowest revenue a new project needs to produce to ensure the profitability of the project. Being aware of the Opportunity Cost or the next best alternative can help businesses if in case the desired revenues are not produced.
Estimating the net benefit and opportunity cost of a project can help you choose a financially viable project. Request a free demo of our procurement platform to gain exclusive insights into cost benefit analysis steps.
Improves credibility by performing sensitivity analysis
Situations might vary and change the estimated outcome. Sensitivity or “what if” analysis can be instrumental in improving the credibility of a cost benefit analysis. It is predominantly used when there is ambiguity over the discount rate. Companies can re-run the analysis with the possible values to test the sensitivity of the cost benefit analysis model.
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