With each project we have a desired end point, a definition of success. We spend time and energy creating solutions and plans to solve a problem or get to a desired end point; However, we may not go ahead with plans because they are not just financially sustainable or just too expensive.
Cost performance analysis is a simple and widespread technique for deciding whether to make a change or move forward with a project.
As the name suggests, simply add the value of the benefits of a course of action and deduct all the costs associated with it. This calculation can be focused on dollars or made on a more qualitative variation.
Costs are either one-off, ie. a single expense, or may occur over a period of time, e.g. weekly monthly, etc. or could be a combination of both.
The benefits of a course of action are most often received over a period of time.
We build this effect of time into our analysis by calculating a payback period. This is the time it takes for the benefits of a project to repay, to the investor or company, the full cost of implementing the project.
In business, companies usually look for repayment over a certain period – e.g. three years is quite normal. This repayment period is usually calculated using complicated mathematical and economic formulas, using interest rates and CPI, etc. and is often described as a percentage return on investment per month. Year.
Let’s say it’s simple for our purposes that it takes 3 years to pay the cost of implementing a zero-interest project, and the CPI is also zero. (What a stagnant world it would be) Percentage return per Year is therefore 100 divided by 3 years corresponding to 33.33%.
Some companies have a project obstacle rate of 30%. This means that they will not invest in the project unless it gives a better rate than 30%. Ie The project must pay for itself in less than 3 years.
In its simplest form, cost / benefit analysis is performed using only economic costs and economic benefits.
For example, a simple cost / benefit analysis of a new mall will measure the cost of building the center and subtract this from the economic benefit to the developer of increased rental income. It will neither measure the cost of environmental damage nor the benefits to local consumers of convenient and easier travel to the stores.
A more sophisticated approach to cost / benefit analysis is to try to put a financial value on these intangible costs and benefits. This can be extremely subjective.
E.g; Is a historic building worth its material cost only if it is in disarray? Is it worth the value of the country it sits on? Or is it worth millions because of the history of the building that lived there, what decisions were made and who was born / died there?
Alternatively, what is the $ value of placing fresh plants in an air-conditioned office?
These are questions that leaders and business / political leaders need to answer and be able to justify their answers to others.
The version of cost / benefit analysis we covered here is simple. As noted, how large sums of money are involved, e.g. Mining projects, oil refineries, major property development, etc., project evaluation is a specialization on its own.