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Importance Of Cost And Benefit Analysis In Decision Making

By on August 26, 2011

Importance Of Cost And Benefit Analysis In Decision MakingCost benefit analysis means analyzing and evaluating ‘costs’ and ‘benefits’ before taking a particular decision. By comparing costs with the benefits, it becomes easier to take a decision.

This technique is frequently used in making critical decisions like expansion of business, entry into a new market, replacement of an old machine, and so on.

Let us understand how Cost Benefit Analysis can be used with the help of an example:

A sole proprietor is having problems in monitoring accounts receivables. As a result of which, he is not able to recover the dues on time. To deal with this problem, he consults his friend who is an accounts receivables manager in a reputed concern. His friend advises him to buy an automated accounts receivable solution. Before investing in the product, proprietor decides to do a cost benefit analysis.

He considers the advantages that he is going to get in terms of easy monitoring, quick collection and reduced accounts receivables balance, better handling of customer issues, less manual interference and so on. While considering the cost factor, he takes into account the expected payback period, current capital availability, implementation process in terms of time and complexity, costs of training staff on the new system and so on.

After doing this analysis, proprietor comes to a decision that the costs associated with maintaining receivables is far greater than the cost of acquiring and implementing the automated solution. He is of the opinion that since there will be a quick turnover of receivables with this system; he will be able to utilize funds for expansion of his business and also improve upon his sales.
Above mentioned illustration indicates a business situation. Cost benefit analysis can also be performed at an individual level.

Let us take an example of how an individual can use this technique for taking a decision.

You decide to replace your desktop computer with a new laptop. You might associate following benefits with a laptop:

a)    Improved technology.

b)    Less space requirement.

c)    Portability. You can carry your laptop at important meetings; do project work, surf internet on the move and so on.

d)    Faster communication. You don’t have to worry about reaching home to reply to important mails.

e)    Limited problem due to power supply disconnection. You can work continuously for two to three hours even when there is no electricity.

Now you evaluate cost on the basis of:

a)    Capital required for buying the laptop. You can also base your decision on whether installment facility is available or not.

b)    Cost of maintenance. You can take annual maintenance or decide to get it repaired as and when the need arises.

Cost benefit analysis can help in taking quick decisions. To have a proper cost benefit analysis, it becomes important to quantify the costs and benefits, otherwise it may become difficult to make an appropriate comparison. Some benefits and costs do not occur immediately, but may occur in the near future. Hence, it becomes important to use the concept of time value of money to arrive at present value of all current as well as future benefits and costs.

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