In a mid-sized business, you're always dealing with competing priorities. Should you launch product A or B? Should you hire an in-house team or outsource? Chances are you're also dealing with limited resources, so it's important to make the best, most cost-effective decisions.

A cost-benefit analysis is a tool financial teams can use to compare priorities and decide which to pursue.

Here's everything you need to know about cost-benefit analysis — what it is, how to use it, and its challenges and benefits.

Table of Contents

• What is a cost-benefit analysis (CBA)?
• How to conduct a cost-benefit analysis
• Cost-benefit analysis formula
• When to conduct a cost-benefit analysis
• Benefits and challenges of a cost-benefit analysis
• Tips to improve a cost-benefit analysis
• Informed decision-making for fast-growing businesses
• FAQ

What is a cost-benefit analysis (CBA)?

A cost-benefit analysis (CBA) is a decision-making strategy your team can use to evaluate whether the value of doing something outweighs the costs. Rather than just guessing which decision makes the most sense or will yield the greatest result, a CBA provides a more structured, data-backed approach.

Conducting a CBA involves adding all the costs associated with a decision or project and subtracting this amount from the total projected benefits. If the projected benefits outweigh the costs, you might decide to move forward. If the costs exceed the benefits, you may decide to pivot.

Let's say a mid-sized sustainable clothing company is trying to decide whether to launch its organic cotton T-shirt for women or its recycled polyester activewear for men.

To help decide which product to pursue, the financial team can run a cost-benefit analysis.

How to conduct a cost-benefit analysis

A cost-benefit analysis includes the following steps:

1. Establish your objectives

What are your goals in performing this analysis? What question are you trying to answer? In our example, the financial team wants to determine which product to launch based on which will deliver the highest profit — the women's organic T-shirt or the men's recycled polyester activewear.

You'll also have to choose a consistent metric for your CBA. The most common and convenient metric is the dollar, which allows you to directly compare costs and benefits. It's important to use the same unit of measurement across both sides of the CBA to ensure accuracy.

2. Identify and estimate all costs

Next, identify the costs associated with each decision. You can break them up into direct and indirect costs as well as intangible and opportunity costs.

• Direct costs: These include expenses related to the direct production of the products, such as materials, manufacturing, marketing, and labour.
• Indirect costs: These include expenses that support overall operations but are not directly linked to your specific product or service. Rent, utilities, web hosting, and administrative salaries are examples of indirect costs.
• Intangible costs: These are typically costs to which it's difficult to assign a monetary value. For instance, reputational damage, reduced customer satisfaction, or employee burnout.
• Opportunity costs: Making one decision means you'll miss out on another decision. Your opportunity costs measure the cost of the decision you give up.

3. Identify and estimate all benefits

Now it's time to identify all the potential benefits expected from each product.

This can include:

• Projected revenue
• Gross profit margins
• Environmental impact
• Customer demand
• Brand alignment

You might need to bring in other experts to help you identify all the possible benefits associated with the products.

4. Assign value to costs and benefits

Once you've identified the costs and benefits, it's time to assign value to each. In this case, you can assign a dollar amount. Determining the value of direct costs is often easier than indirect costs.

To help with value estimates, you can refer to market research, historical data, or supplier quotes. For indirect, intangible, and opportunity costs, do your best to estimate.

5. Record your assumptions

As you work through this process, be sure to document any assumptions your team makes. This can help others understand your rationale for a decision.

Record any assumptions used when estimating the value of costs and benefits, such as assumptions about price, production costs, marketing expenses, customer adoption rates, and potential risks.

6. Review and recommend

Based on your analysis, which product comes out on top? Which one presents a stronger business case? Does it make sense to move forward with the project? With the numbers to back up your options, you can now review your options and make an informed recommendation.

Cost-benefit analysis formula

There's a simple equation you can use to conduct a cost-benefit analysis:

Net benefit = Total benefits - Total costs

Let's say the total benefits for the women's organic T-shirt line are $150,000. The total costs come to $100,000. This gives a net benefit of $50,000.

Net benefit = $150,000 - $100,000 = $50,000

You can also calculate cost-benefit analysis as a ratio using the following equation:

Cost-benefit ratio = Total benefits / Total costs

Cost-benefit ratio = $150,000 / $100,000 = $1.50

• This means you can expect to earn $1.50 for every $1.00 the company spends.

When to conduct a cost-benefit analysis

For a growing business managing limited resources, conducting a cost-benefit analysis is a valuable strategy to make more informed decisions — which are crucial to the healthy development of your business. By systematically weighing the costs and benefits of each option, you can prioritize investments and reduce risks.

Here are some situations where you might use a CBA.

When deciding between two or more options

If you're trying to determine if it makes more sense to launch product A or product B, a CBA can help clarify which option is likely to offer more value relative to its cost.

Before launching a new product or service

A CBA can help determine if the cost of launching a new product or service is worth it. Is the product likely to bring in more value than the cost associated with developing and marketing something new?

Before investing in equipment or technologies

Should you invest in new AI technology for your business? Should you upgrade your manufacturing equipment? A CBA helps assess whether the long-term benefits justify the upfront costs.

Before expanding the business

When deciding whether to open a new location or expand into another province, a CBA can help you weigh your options. Does the projected revenue and customer growth outweigh the costs associated with expanding?

When deciding to hire versus outsource

For key roles, a CBA helps compare the costs and benefits associated with hiring a full-time employee versus working with a contractor. A CBA can help determine what makes the most financial and operational sense.

Benefits and challenges of a cost-benefit analysis

Why should you consider using a cost-benefit analysis as part of your mid-sized business decision-making strategy?

Here's a list of pros and cons to consider:

Pros of a cost-benefit analysis

• Data-driven: The cost-benefit analysis is backed with data and can help remove some of the emotion from decision-making.
• Effective allocation of resources: If your mid-sized business is working with limited resources, a cost-benefit analysis can help ensure the effective use of time, money, and personnel.
• Prioritization: When trying to decide between competing priorities, a cost-benefit analysis can help you determine which one is most valuable.
• Deep thought: Coming up with a comprehensive list of costs and benefits requires deep thought and analysis. This can help your team uncover costs and benefits you might not otherwise think of, leading to more robust and reliable findings.
• Increased accountability: A CBA provides structure to decision-making. It's easy to share what assumptions were made and how conclusions were drawn from the data.

Cons of a cost-benefit analysis

• Poor data quality: Without robust data collection or forecasting tools, some mid-sized businesses might not have access to quality data. This could lead to misinformed decisions.
• Challenges around assigning value: This can be tricky when it comes to some indirect costs.
• Over-reliance on CBA: Businesses should be cautious about becoming over-reliant on cost-benefit analysis results. Also, cost-benefit analysis is not always the best (or only) way to make a complex decision.
• Less effective for long-term projects: It's harder to conduct an accurate CBA for longer-term projects because things can change. For example, it's more difficult to account for factors like inflation when trying to estimate costs.
• Time-consuming: When done right, a CBA can take up a lot of time. Creating a comprehensive list of costs and benefits and trying to track down the exact dollar amount of each is not a quick task.

Tips to improve a cost-benefit analysis

To maximize the effectiveness of the cost-benefit analysis, consider the following tips:

• Don't forget intangible costs. It's typically easier to identify and estimate the costs associated with tangible items, but don't forget about intangible costs like brand reputation, customer satisfaction, decision-making delays, and employee burnout. Neglecting to include intangibles in your analysis can skew the results of your CBA.
• Document all assumptions. Make sure you clearly document how you came up with your estimates. What research, data, or expert opinions did you rely on? Clear documentation will help if you want to revisit your analysis in the future, and it can help you learn from your past decisions.
• Include a range of stakeholders. Don't rely solely on the finance team to complete the CBA. Having insights from different departments — such as marketing, human resources, and product development — can help you identify a more comprehensive list of costs and benefits.

Informed decision-making for fast-growing businesses

A cost-benefit analysis can act as a powerful decision-making tool for scaling businesses. When combined with experience, judgement, and qualitative insights, it helps financial teams and leaders make important, well-informed decisions.

With QuickBooks, it's easy to track, organize, and report all business data. Plus, the budgeting and forecasting tools can provide valuable estimates of future costs and revenues to help with CBAs. Don't lose more time — take your business to the next level by using QuickBooks Online Advanced to streamline your financial management.