Cost-benefit analysis explained: How teams decide whether a tool, project, or process is worth the investment

Every decision is a sacrifice, and each sacrifice has the opportunity for tremendous reward. That’s why cost-benefit analysis is so important before adopting a tool, project, or process. With this analysis, leaders and teams identify the costs and risks involved with a decision (e.g., financial costs and opportunity costs) as well as the potential rewards (e.g., financial benefits and efficiency gains). By comparing risk and reward, leaders can make a more educated decision.

Cost-benefit analysis isn’t as simple as boiling down the two sides to a single number, the way an ROI (return on investment) calculation might. Generic templates and frameworks are also limited in their usefulness, since real decisions involve hidden costs and benefits that aren’t easily turned into a dollar figure.

In this guide, you’ll learn how to run this analysis and what to avoid.

What cost-benefit analysis actually measures

A cost-benefit analysis isn’t just an equation of dollars in and dollars out, the way an ROI calculation is. It’s also distinct from a total cost of ownership (TCO) evaluation. Cost-benefit analysis is about a single question: “Is this worth it?” TCO answers a different question: “How much will this cost?” The goal of TCO is to go beyond the “sticker price” of a tool, project, or process to encompass all the costs you’ll actually pay, from maintenance costs for a software tool to opportunity costs paid for pursuing one project over another. It doesn’t cover benefits at all.

You’ll usually evaluate TCO when performing a cost-benefit analysis to get a better picture of the actual costs involved in the decision you need to make.

Direct costs vs. indirect costs

The difference between direct and indirect costs is in how closely tied they are to the decision you’re evaluating. A direct cost is an obvious, direct consequence of making a specific decision. The license cost of a piece of software, the price of a contractor for a specific project, and the time spent improving a process are all direct costs.

Indirect costs are less obvious, and usually spread out over multiple teams or a longer timeline. The hours spent training people on a new tool, the temporary productivity dip as a team adjusts to a new contractor, and the meetings booked to align on a new process are indirect costs.

Quantifiable benefits vs. qualitative benefits

Quantifiable benefits are benefits you can easily assign a dollar value to. The forecasted revenue from a new product, the license savings from switching software, and reduced turnover from a new employee wellness initiative are all examples of quantifiable benefits. These benefits are easy to measure and easy to factor into your cost-benefit analysis.

Qualitative benefits aren’t as easily turned into a clear dollar value. Improved morale, better collaboration, and increased audit readiness are examples of qualitative benefits. These are usually factored in a cost-benefit analysis by finding quantitative equivalents (e.g., reduced turnover for improved morale). If they can’t be quantified at all, they’ll still be listed so everyone can be aware of them, but won’t be factored into the actual calculation part of the analysis.

The cost-benefit analysis process (step-by-step)

Define the decision and time horizon

Before you begin your analysis, you need to state the decision you’re evaluating in a clear way. Stakeholders need to be involved at this stage so they can agree on the specifics of the decision. You’ll also need to establish the period your analysis is intended to cover (i.e., the window that costs and benefits have to fall in to be considered).

Inventory all costs (including indirect and ongoing costs)

Identify the costs involved in your decision and give each one a line item in a spreadsheet. This should include indirect costs and recurring costs. Each line item should name the cost, include an estimated dollar value, categorize the cost as direct or indirect, and include detailed notes or assumptions.

Inventory all benefits (both quantifiable and qualitative)

List all of the benefits a decision could potentially lead to, representing each one as a line item in the same spreadsheet as your costs. Both quantifiable and qualitative benefits should be listed here and given a dollar value. Find a way to quantify the impact of qualitative benefits and include your reasoning in each line item. If you can’t, make sure you still list them with an explanation so stakeholders are aware of them.

Assign values and confidence levels to each line item

Each cost and benefit should have a single dollar value associated with it, with an explanation detailing how confident you are in that amount. Add a confidence level to each benefit and cost, which should cover how likely they are to occur and how accurate you believe the associated dollar value is.

Compare against a payback period or breakeven threshold

A payback period is the amount of time it takes for a decision’s benefits to match its costs—how long it takes for a decision to pay itself back. You can do this by forecasting what you’ll gain in benefits over a year’s time.

The breakeven threshold is the maximum payback period you’re willing to accept for a decision to be worth it. So, for example, you may decide that a decision needs to break even within two years to be worthwhile. Any payback period greater than two years means you don’t go with that decision.

Stress-test your assumptions with scenarios

With scenarios, you essentially give your analysis a margin for error that allows you to make a better decision. Even just two scenarios, a best case and a worst case, can make your analysis much more accurate.

To build a scenario, you just need to adjust the total benefits and costs of your analysis as a percentage of your initial figures. The result of that calculation then factors into your payback period, telling you if a decision falls under your payback threshold across all scenarios. A best case scenario might, for example, adjust costs to 80% of their original value and benefits to 110%. A worst case scenario might be 120% and 80%, respectively.

Common obstacles that derail cost-benefit analysis

When performing a cost-benefit analysis, consider these common obstacles.

Lack of reliable data

Estimating costs and benefits with any amount of confidence requires strong data. Not all organizations have that level of data, or the resources to quantify costs and benefits. Because these need to be evaluated across teams and departments, you’ll often need to leverage data functions with varying degrees of sophistication.

Disagreement among stakeholders

Any decision important enough to warrant a cost-benefit analysis will have multiple stakeholders, and these stakeholders will disagree on which benefits and costs should actually factor in your analysis. Additionally, they’re likely to disagree on how these should be quantified.

Justifying decisions that have already been made

Sometimes, a cost-benefit analysis is a foregone conclusion. A leader somewhere has already decided that a certain decision needs to be made, and the cost-benefit analysis is more about checking a box than actually running the numbers.

No ownership of follow-ups

All too often, a cost-benefit analysis is completely forgotten after a decision is made. No one compares the forecast to the actual numbers, meaning your organization never improves the way it performs this analysis. Not only that, but you never end up knowing the true cost of the decisions you make.

Fewer costs, more benefits

A cost-benefit analysis is an ongoing discipline for making assumptions around decisions more explicit and testable, rather than a one-time spreadsheet exercise. Building this practice into the decisions you make improves alignment among stakeholders, optimizes the way you use your budget, and ensures that you’re consistently improving on processes and initiatives.

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