Defining Cost Benefit Analysis
A cost benefit analysis is used to evaluate the total anticipated cost of a project compared to the total expected benefits in order to determine whether a proposed project is worthwhile for a company or team.
Although this evaluative method is relatively easy, straight forward, and versatile, there are a number of arguments against using a cost benefit analysis as a decision-making tool. A company or team must evaluate the overall goals and necessities of a project and then compare those priorities to the potential drawbacks to determine if writing a cost benefit analysis is a worthwhile investment of time and resources.
The Disadvantages of a Cost Benefit Analysis
1. Potential Inaccuracies in Identifying and Quantifying Costs and Benefits
A cost benefit analysis requires that all costs and benefits be identified and appropriately quantified. Unfortunately, human error often results in common cost benefit analysis errors such as accidentally omitting certain costs and benefits due to the inability to forecast indirect causal relationships. Additionally, the ambiguity and uncertainty involved in quantifying and assigning a monetary value to intangible items leads to an inaccurate cost benefit analysis. These two tendencies lead to inaccurate analyses, which can lead to increased risk and inefficient decision-making.
2. Increased Subjectivity for Intangible Costs and Benefits
Another disadvantage of the cost benefit analysis is the amount of subjectivity involved when identifying, quantifying, and estimating different costs and benefits. Since some costs and benefits are non-monetary in nature, such as increases in customer and employee satisfaction, they often require one to subjectively assign a monetary value for purposes of weighing the total costs compared to overall financial benefits of a particular endeavor. This estimation and forecasting is often based on past experiences and expectations, which can often be biased. These subjective measures further result in an inaccurate and misleading cost benefit analysis.
3. Inaccurate Calculations of Present Value Resulting in Misleading Analyses
Since this evaluation method estimates the costs and benefits for a project over a period of time, it is necessary to calculate the present value. This equalizes all present and future costs and benefits by evaluating all items in terms of present-day values, which eliminates the need to account for inflation or speculative financial gains. Unfortunately, this poses a significant disadvantage because, even if one can accurately calculate the present value, there is no guarantee that the discount rate used in the calculation is realistic. A cost benefit analysis template has been developed to help reduce the likelihood of incorrectly calculating the present value of costs and benefits, and it is available for download in the Project Management Media Gallery.
4. A Cost Benefit Analysis Might Turn in to a Project Budget
Another disadvantage seen when utilizing a cost benefit analysis is the possibility that the evaluative mechanism turns in to a proposed budget. When a project manager puts together a cost benefit analysis and presents it to a leadership team, the leadership team might view the expected costs as actual rather than estimation, which may lead to misappropriating costs and setting unrealistic goals when approving and implementing a project budget. This can put a project manager in an unfavorable situation when he or she attempts to control costs in order to maintain the expected profit margin.