What is Cost Benefit Analysis?
A cost benefit analysis (CBA) is a process that involves evaluating an intended course of action by determining its present and intended value. It is sometimes referred to as benefit cost analysis and it’s a technique that estimates the strength and weaknesses of alternative options during project evaluation, project proposals, environmental assessments, business transactions, health care economics, etc.
The technique is used to determine the best feasible approach in any intended project or investment by simply calculating and comparing the costs and benefits.
In CBA, the costs include both monetary costs and negative effects while the benefits are the positive factors. It adds all the positive factors andsubtracts all the negatives.
The difference between the two will indicate whether the planned action is feasible. The motive behind every CBA is to determine if the project is justifiable and investment worthy. It also provides a basis to compare the different options available for the project by comparing the expected cost of each option against the expected benefits to ascertain which will be the most practical
Government and non-governmental agencies and even private organizations employ it in policy assessment exercises. It is used in ranking alternative from the cost benefit perspective. When calculated accurately, it can also help to make choices that affect the welfare of the people; highest welfare at the lowest negative impact.
For business or economic investments, a CBA allows investors to be able to make educated decisions about their investment choice(s), means of profit making and also in determining the possible future of a company and in health care, especially in cases of limited funds, CBA helps policy makers decide on budget allocation and comparing the effectiveness of different health interventions.
It’s also applicable in transport investment and has been widely used in the US and UK.
The principles of Cost Benefit Analysis include:
• The study area should be defined
• There should be a common unit of measurement
• Benefits are usually measured by market choices
• Gross benefits of an increase in consumption is an area under the demand curve
• Some measurements of benefits require the valuation of human life
• The analysis of a project should have with vs. without comparison
• The error of doubly counting costs or benefits should be avoided
• There should b an acceptable or standard decision criteria for projects
• CBA Valuations should show producers or consumers valuations as revealed by their actual behavior
For environmental assessment and related projects, CBA is employed to assess the positive and negative impacts of projects.
This scope includes the effects on users, non-users, external effects and other social benefits, controversies occur in CBA, especially when expressing costs or benefits in monetary and non-monetary terms such as valuing the human life and the environment’s health (but this can be avoided by using cost-utility analysis).
The accuracy of a CBA is feasible, but it’s dependent on the accuracy of the estimates of the individual costs and benefits. The estimates can be flawed when bias exists or even in cases of reliance on data made available by past projects and the inappropriate use of heuristics.
The use of CBA is not limited to projects or public policies alone, it can be used in making informed decisions at household levels also; top determine the allocation of funds to different household expenses and budget choices.
It’s similar to the use of opportunity costs, comparing the benefits and costs of using funds for certain purposes and making a choice based on that.