Cost Benefit Analysis

  • Feb 19
Cost Benefit Analysis

There are multiple ways to make decisions when faced with a critical crossroads. Some of us will shoot from the hip and trust our gut. Others may freeze and fail to even make a decision. Then there are those who will methodically map out the theoretical consequences of each option and go with the one that provides the most value add or, in some cases, does the least amount of damage. This is a Cost-Benefit Analysis.

So Many Variables to Analyze

Performing a Cost Benefit AnalysisThe decision-making process in a business is nothing to be taken lightly, and in most cases, can be a labyrinth to navigate. Multiple elements play a role in determining how you’ll arrive at your final destination, the decision. However, there’s one standout variable that dictates the course of action you will take – time. Given enough time, anyone can make the right decision, but unfortunately time is finite. Sometimes a decision has to be made immediately and, thus, you don’t have the luxury of weighing out your options. You either make a quick decision or opt to do nothing – which is a decision in and of itself – and hope for the best.  

Back in January of 2019, Apple faced a difficult decision with no easy solution. The roll-out of a new iPhone upgrade which introduced the group FaceTime feature had a critical bug. You could call someone via FaceTime and listen to their phone’s microphone, even if they haven’t answered. The bug was brought to their attention by a 14-year-old kid. For a company that prides itself on it’s security and privacy, this was a major screw-up. Many decisions had to be made and quickly, leaving little time to analyze potential outcomes.  In the end, they managed to minimize the fallout and save some face.

Managerial Accounting 

Managerial Accounting for Analyzing CostsMaking the right business decisions starts with having a solid grasp of Managerial Accounting. Not to be confused with Financial Accounting which, in essence, simply gives you a 10,000-foot view of the financial health of a company. Cost-Benefit Analysis is the backbone of Managerial Accounting. Understanding how variables interact with one another is critical in making sound business decisions. It’s call Cost-Benefit Analysis because you can always attribute a cost to every decision made.

In order to properly execute a meaningful Cost-Benefit Analysis, there are a few things you should keep in mind. First, what is the dependent variable and its desired outcome? For example, you own a cookie shop and you’re trying to find a way to reduce the cost of your cookies. There you have it, the cost of your cookies is your dependent variable and reducing that variable is the desired outcome. Next, we need to identify the independent variables, the elements which have a direct impact on the dependent variable and, thus, the ultimate outcome. Sticking with the cookie example, you could consider the sugar, butter, eggs, oven, mixer and the list goes on in regard to what is needed. Now, we get to start the analysis part. We begin looking at the independent variables by themselves, but also in conjunction with one another to see how they will affect the dependent variable.

Deeper Analysis

Managerial Accounting and Cost Benefit AnalysisAnalyzing an independent variable by itself could be as simple as looking at the sugar and trying to find a cheaper alternative since we know this will directly lower the cost of the cookie. However, we also need to analyze how using a different sugar could affect the other ingredients. A cheaper sugar is likely less refined and that could require additional heat or longer baking time, which requires more energy and money. Yes, if you were only making one cookie then the effects would be negligible. But at what volume does the effect start to have material consequences on your bottom line. 

When faced with an important business decision, the best course of action may not be as apparent as one may think. Sometimes the savings you obtain in one area may cost more in another, and you would have never known had you not performed a Cost Benefit Analysis. While the cookie example used here may seem overly simple, there is plenty more to learn. Consider taking one of our Cost Benefit Analysis courses for HRCI/SHRM, CPA, or APA credits to learn more about this accounting skill. It’s important to enhance your ability to make the optimal choice the next time you’re faced with a crucial business decision.

Article written by Vaughn Pourchot