Cost-benefit analysis may be defined as a process of estimating good and bad sides of considered alternatives when deciding about a new project. In other words, it is a calculated process for finding the ratio between costs and benefits of a project and determining if it is worth its price. When the analysis is finished, it is known which project is better in terms of finance and anything else that might be important.
The part of cost-benefit analysis is putting a monetary value on things that are not measurable by money (for example, living in a city versus living in a country). While transferring the benefits into monetary values some of the meaning might be lost, but it is important that this can be done. Of course, the results are not as precise and there is always a risk because of the factors that simply can not be measurable.
Roughly speaking, cost-benefit analysis has two main purposes:
- Justification – determining if the decision will be the best among all the options;
- Comparing – comparing all the available options by cost and possible benefits.
Those purposes can not really be separated one from another. The result of comparing is getting the answer to the question: which of the options is the best? The result of justification is getting the answer to the question: is the given option the best possible? These two processes can give the best results when combined.
Practical application of the cost-benefit analysis started as a result of the stimulus by the Federal Navigation Act from 1936. It has required that waterway system projects should be given to those with the best offer in terms of price and quality. That is the first known example of cost-benefit analysis as it is defined today.
Cost-benefit analysis has a wide usage. It is used in private business sector, as well as in the governments and many more organizations. The purpose of cost-benefit analysis is to predict if the benefits of the investment will be greater than its cost and it can be used in many fields of industry, science, technology etc.
In order to get the most objective results, cost-benefit analysis presents its findings in monetary terms. However, there are some fields whose worth can’t be measured by money, for example medicine and health services. Cost-effectiveness analysis’ results are presented in the form of a ratio and a formula is slightly more complicated since there are many factors involved.