SAD-Procedure For Cost/Benefit Determination

 There are four steps for cost/benefit analysis.

1.costs and benefits identification
2.classification of costs and benefits
3.Select evaluation method
4.Interpret results of the analysis and final action

Costs and benefits identification

There are two types of identification-easily identifiable and non-identifiable. In easily identifiable the costs and benefits can easily identify from company invoice payments or canceled checks. Example for this is direct costs and direct benefits. In the second type, the costs and benefits are not easily identifiable. Example for this is opportunity costs and benefits. These are the costs or benefits forgone by selecting one alternative over another. They do not show in the organization accounts and therefore are not easy to identify.

Classifications of costs and benefits.

There are three classifications

1. Tangible or intangible costs and benefits
2. Direct or indirect costs and benefits
3. Fixed and variable costs and benefits.

1. Tangible or intangible:

Tangible costs and benefits are those that can be easily identified and measured.

Ex for tangible costs are Purchase of hardware and software, personnel training, employee salaries.ex for tangible benefits are completing jobs in fewer hours, producing report with no errors.

Intangible costs and benefits are those that cannot be easily identifiable and measured accurately.  Ex for in table costs are employee morale problem caused by new system, lowered company image.  Ex for intangible benefits are more satisfied customers.

2.Direct or indirect

Direct costs and benefits are those functions that are directly applied to the operation  Ex for direct costs is purchase of a box of diskettes. A new system that can handle 25 percent more transactions per day is a direct benefit.

Indirect costs and benefits are those whose results of the operations that are not directly associated with given system or activity. Indirect costs are referred to as overhead.  Ex-indirect costs are insurance, maintenance, and protection of computer center, air conditioning.  Indirect benefits are defined as a by-product of another activity or system.

3.Fixed or variable

Fixed costs and benefits are constant, they do not change. Fixed costs are insurance.ex for fixed benefits is decrease in a number of personnel by 20 percent resulting from the use of a new computer.

Variable costs and benefits are changeable. They are not constant

Select evaluation method

When all the financial data have been identified and broken down into cost categories, the analyst must select a method of evaluation. Several evaluation methods are available. The common methods are

1.Net benefit analysis
2.present value analysis present value
4.payback analysis
5.break-even analysis flow analysis

1. Net benefit analysis:

Net benefit analysis simply involves subtracting total costs from total benefits. It is easy to calculate, easy to interpret, easy to present. The main disadvantage is it does not account for the time value of the money and does not discount future cash flow.

2.Present value analysis:

The formula for finding present value analysis is


Where p=present value of investment  F=future value of an investment , I=interest rate , n=number of years

3.Net present value:

The net present value is equal to discounted benefits minus discounted costs. This value is relatively easy to calculate and accounts for the time value of money.

4. Payback analysis

The payback method is a common measure of the relative time value of a project. It determines the time it takes for the accumulated benefits equal to the initial investment. Obviously, the shorter the payback period, the sooner a profit is realized .This is calculated by Overall cost outlay/annual cash return.

5.Break-even analysis

This method compares costs of the current system and costs of the candidate system. When these both costs are equal then it is called break even .if the cost of candidate system exceeds the costs of existing system then it is called investment period. If the cost of candidate system is less than the existing system then it is called return period.

6.Cash flow analysis

Cash flow analysis keeps track of accumulated costs and revenues on a regular basis.i.e it will collect detailed information about the flow of cash in the system.

Interpret results of the analysis and final action

When the evaluation of the project is complete, the results have to be interpreted. This entails comparing actual results against a standard or the result of an alternative investment. After comparing the final action is to select the best candidate system.

In summary cost/benefit, analysis is a tool for evaluating projects rather than a replacement of the decision maker. Like any other tool, however, it has problems

1.valuation problems.
Intangible costs and benefits are difficult to quantify and tangible costs are generally more pronounced than tangible benefits.

2.Distortion problems. There are two waysides distorting the results of cost/benefit analysis. One is the intentional favoritism of an alternative for political reasons. The second is when data are incomplete or missing from the analysis.
3. Completeness problems. Occasionally an alternative is overlooked that compromises the quality of the final choice. Furthermore, the costs related to cost/benefit analysis may be on the high side or not enough costs may be considered to do a complete analysis
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