You know you need to invest in your business so that you can continually grow it, but sometimes it’s hard to know which expenses are essential and which will just end up costing you money. That’s where a Cost Benefit Analysis (CBA) comes in handy. This financial tool will help you assess the strengths and weaknesses of any financial activity you’re considering.
Using a Cost Benefit Analysis can help you determine if an investment is a good idea, as well as to weigh the costs against the benefits of it.
When To Use Cost Benefit Analysis
A CBA is most useful in making simple financial decisions. More complex ones may require an advisor or other financial calculation tools.
Here are a few examples of when you might choose to use a CBA:
- When you’re considering hiring an employee
- When you want to invest in costly equipment
- When you want to start a new project
How To Create Cost Benefit Analysis
Now let’s walk through how to use a CBA. Let’s use the example of hiring an employee for this illustration.
Step 1: Research Costs
As best you can, determine all costs associated with what you want to invest in. If you want to hire an employee, you can find out what competitive salaries for that role are in your area.
Look at alternative options too, like hiring a freelancer or part-time employee. Factor in all expenses, including health insurance and other benefits.
Consider costs you might not have initially thought of. For example, training a new employee may cost you money by taking you out of your normal work schedule to onboard the new hire.
Your business also might slow a bit as it takes time for the new employee to get a hang of things.
Step 2: Define Benefits
What benefits will you realize if you proceed with this investment?
If you’re looking to hire help, how would it free you up to work on other aspects of your business?
How much could more money your small business bring in with the extra set of hands?
Consider the benefits over time, not just now.
It’s important to remember that employees want to feel valued and care for. This doesn’t necessarily mean buying an expensive healthcare plan or giving unlimited time off if you can’t afford it, but ensure they at least have proper, basic benefits.
Step 3: Assign Dollar Amount To Benefits
This can be tricky, as many benefits aren’t easily weighed in monetary value. Come up with a value as best you can.
For example, if you’re hiring a salesperson, you may be able to estimate that she could bring in an additional $100,000 in sales a year.
That’s a value you can work with. Or, hiring an assistant might free you up from 40 percent of your daily tasks, letting you focus on sales and strategy.
This could lead to more revenue in sales on your end through successful marketing strategies and sales pitches to higher end clients. Take 40 percent of your annual salary to come up with that value.
Step 4: Compare The Two
Now that you’ve got a simple apples-to-apples comparison (dollar values), weigh the benefits against the costs.
Keep the payback period in mind in this step: You may not reach break even on your costs for a few years, so determine how long you are willing to wait to have those benefits repay the costs.
For example, hiring an employee at $75,000 may net you an additional $50,000 in sales the first year, but in the second and subsequent years, you estimate an additional $100,000. So from Year 2 on, your investment of $75,000 a year would be more than covered.
It may, in fact, cost you more the first year (training and onboarding costs) and then get cheaper over time, while your benefits stay the same or even increase.
That’s a sign that it’s a good idea to invest in the new hire. Consider taking out a small business loan to cover the temporary higher expenses.
Invest in yourself and your small business.
Step 5: Factor in Non-Financial Details
While the above process is a simple one, it doesn’t take the whole story into account.
In the hiring example, consider whether you’re outfitted to have someone work with you. If you work from home, you probably don’t need dozens of employees.
So you may have to shift your work situation and your mindset to bring someone on. Also, do you have management experience?
Do you know how to be someone’s boss?
It’s intangible factors like these that you need to consider as well when making the decision, as it’s not just financially-based.
If you’re new to management, there are plenty of online resources to help you learn how to do so. However, if the hiring example doesn’t apply to you, not to worry.
There are still a wide variety of resources online to help you with your expense questions and needs.
Helpful Resources Online
While you can just do a quick CBA on a piece of paper, you may find these resources helpful.
TidyForms: On this site, you’ll find examples of Cost Benefit Analyses that can guide you to creating your own.
Bright Hub Project Management: This article walks you through the steps of creating a CBA and has a free template to download at the end.
University of Pennsylvania: This document from UPenn is more of a summary style Cost Benefit Analysis, but can help you give thought to the investment you’re considering and help you weigh both the financial and intangible factors to make a decision.
State of Connecticut: There are several forms and spreadsheets here to help you categorize and identify expenses as you build your CBA.
Investing and growing your business is vital for your success as an entrepreneur.
However, it can be tricky to know which expenses are essential and worth the cost versus ones that will only deplete your cash flow.
A CBA can help you figure this out. It’ll outweigh the costs and benefits of any financial activity you’re considering investing in and help you determine whether or not to go through with it.
Have you ever used a Cost Benefit Analysis to make important financial decisions? How did it help you?
Constantina Kokenes is a Content Specialist at Kabbage, a small business loans provider. She holds a Master’s Degree in Journalism from Northwestern University. When not in the small business world, Constantina loves cooking, baking, going on hikes, and playing with her cat and chinchilla.