Cost Analysis
Cost analysis, also known as cost-benefit analysis,
is the process of calculating the potential earnings
from a situation or project and subtracting the
total cost associated with completing it.
Why is cost analysis important?
Helps decision-making
Cost analysis allows professionals to make
decisions regarding future projects by allowing
them to weigh their costs against their profits. If
the project cost is higher than the predicted
earnings, professionals can make the necessary
changes to the project to increase the earnings or
lower expenses. This helps maintain profitability
without sacrificing essential company projects.
Keeps stakeholders involved
Cost analysis ensures that companies involve stakeholders in
the decision-making process.
Solves problems
Cost analysis can help identify financial problems and find
solutions. Regular cost analysis reviews can help you identify
which factors impact a project's profitability and address them
directly.
How to calculate cost analysis
1. Determine the reason you need a cost
analysis
The way you use a cost analysis can vary based
on your reason for doing so. Before you start,
determine why you need a cost analysis to
better understand what variables you can use.
For example, you might pull budget information
from previous initiatives if you're doing a cost
analysis to create a project budget.
2. Evaluate cost
The next step is to evaluate the costs
associated with a project. It may be useful to
write all of them on a list so that it's available
for future steps. Be sure to consider any
unexpected costs associated with the project
and how the costs might change over time.
Here are the factors to consider when evaluating cost:
• Direct cost: This is the cost associated with each product variable, like
product type, customer, service or activity.
• Indirect cost: These expenses are not directly associated with the
project but the company needs to include them in the budget. They
can include rent, utilities and administrative expenses.
• Real cost: This is the cost associated with the actual production of a
project, like labor and material costs.
• Tangible cost: This is the cost that relates to supporting a project, like
purchasing tools and paying employees.
• Intangible cost: Factors that impact the outcome of a project, like
changes in production levels or decreases in customer satisfaction, are
intangible costs.
6. Subtract the cost from the outcome
The next step involves finding your cost analysis
ratio by subtracting the total costs from the
project's estimated benefits. For example, if a
project costs $1,000 and the benefits are
$2,500, then $2,500-$1,000=$1,500. You can
produce several cost analysis ratios if you have
multiple different scenarios for how much profit
a project could generate.
7. Interpret the results
Once you have the value of your cost analysis, it's
important to interpret the results so you can
decide if you want to pursue the project.
Generally, if your results meet the goal of the
income you want to earn from the project, then
it's a good idea to pursue the project. If the cost
analysis shows that you won't meet your goal,
consider lowering the project's cost or finding
ways to raise the profits.
Example of cost analysis
Here's an example of cost analysis for a project:
A clothing company wants to determine if they might launch a new clothing
line by next spring. They decide that a cost analysis would offer them insight
into how much they would earn from the project to compare profit and
costs. They've decided that their goal is to generate over $1,000 with the
spring clothing line. Their accountant writes all costs associated with the new
clothing line. They determine that their direct costs would total $500, their
indirect costs total $400, their real costs total $600, their tangible costs total
$200 and their intangible costs total $500. Next, they pull information from
previous clothing lines to analyze financial similarities. They find that their
winter clothing line from two years prior has similar costs, so they know to
analyze how well they profited from that clothing line sale. Upon analyzing
the previous sale, they found that they could profit greatly from the sale.
Their next step involves determining all the stakeholders within their
upcoming spring clothing line. They identify five separate stakeholders
and make them aware of the cost analysis. They also consult with the
stakeholders to get advice on maximizing the benefits while
minimizing costs. Next, the company enlists a financial analyst's help
to list the clothing line's potential benefits. They find that if they sell
out their entire inventory, they can generate $4,000. To finish their
cost analysis, they add up all of their costs, which are:$500 + $400 +
600 + $200 + 500 = $2,200.Finally, the accountant subtracts the total
number of costs from the benefits, which is:$4,000 - $2,200=
$1,800.This means that the company nets $800 more than it expected.
Because of this, the company decides to pursue the project since the
cost analysis shows the possibility of an excellent profit margin.
