How to do a cost-benefit analysis

When you’re making a decision, what tips the scale for you? Do you make a list of pros and cons, and move forward if the pros outweigh the cons? Or do you go with your gut?

In the startup world, your decisions may have far-reaching implications. Everything from hiring to raising capital to implementing tools for your team is tied back to some business objective.

There’s a lot of benefit to methodically weighing your options. A cost-benefit analysis helps you think through the potential outcomes. It can help you decide whether or not to move forward — or how you might prioritize a project against another.

What is a cost-benefit analysis — and why should you do one?

A cost-benefit analysis quantifies the total costs and potential rewards of a business decision. If the benefits outweigh the costs, you’ll probably want to proceed (assuming you have access to the necessary capital for any initial costs).

Completing a cost-benefit analysis aims to put some data behind your decision-making. Undoubtedly, you’ll need to make some assumptions and projections (which we’ll get to in just a bit). However, with data, you’re giving some weight to your pros (benefits) and cons (costs), rather than simply making a list.

A cost-benefit analysis makes the most sense for large projects or investments requiring substantial resources. A thorough analysis looks at a lot of factors and can take time to prepare, which is a resource cost by itself. A subscription for an app that will increase your team’s productivity doesn’t need a cost-benefit analysis. An investment in an enterprise-grade solution that may take years to achieve ROI, on the other hand, may give you more pause and warrant a more involved assessment.

The more systematic you can be with your cost-benefit analyses — when and how you do them — the more confidence you’ll feel with making decisions in the future.

A 4-part framework for conducting a cost-benefit analysis

There are a few basic steps you should follow when conducting a cost-benefit analysis, no matter the project or investment.

Throughout these steps, you’ll need to quantify factors that may not have a hard number. For example, how do you measure an increase in employee satisfaction? You’ll need to have some way of assigning a value, whether it’s a point system you create, potential time savings, or other organizational impact.

Ultimately, you should gather your findings from this framework into a simple report. You can share it with other decision-makers, or keep it with the project documentation.

1) Project scope

To start, you’ll need to outline the specifics of your project or investment: what problem are you trying to solve, and what are your goals?

It might be something as straightforward as adding a new director-level role to the team, or something more involved, such as selecting and implementing a CRM.

Just as important is to outline what’s not included in your project scope. As any product team knows, scope creep is real. You might start with a website overhaul and end up tackling brand messaging. If you allow your scope to expand, your cost-benefit analysis won’t be accurate.

In your scope, you’ll want to outline the expected timeline, resources needed, and any limiting factors (such as budget). You’ll also want to identify any decision-makers, key stakeholders, and the people who will help you gather information to analyze costs and benefits. Price, for example, may come from getting quotes from several outside parties.

2) Direct and indirect costs

Any project or investment will have both direct and indirect costs.

Your direct costs may be a purchase price, salary, or other investment in a resource. You’ll want to think about upfront costs as well as any ongoing costs. Indirect costs could be a larger electric bill needed to run additional equipment.

Then you’ll have costs that are even harder to measure, such as the impact on your customers or employees. You may have opportunity costs associated with waiting if the project can make you more competitive. Or you may face potential legal or regulatory risks if you don’t act in a timely manner.

3) Benefits — and what they’re worth

Next, you’ll list out all the benefits and their impact on the organization.

Benefits are even harder to measure than indirect and intangible costs, because (most of the time) they’re based on an assumption you have. You assume that you’ll have increased revenue or decreased churn. You assume that you’ll have improved customer or employee satisfaction.

Make sure your assumptions are rooted in some type of realistic expectation. You might know, based on connections to others in the industry, that an HR hire will have an impact on employee satisfaction. You have a good reason to believe that you’ll see similar results, even though it’s an assumption.

If you know that a benefit is “time savings,” it’s a bit easier to quantify. You can estimate the amount of time saved, multiplied by the impacted employees and their associated salaries. If you’re considering a product or solution, a salesperson can help you calculate ROI.

While benefits can’t always be measured in a known quantity, you can start with the potential number of employees or customers impacted, the revenue potential, and/or the timeframe in which you’ll start to see results.

4) Comparing the costs and benefits

The formula seems to compare costs and benefits seems straightforward. Moving forward with the project makes sense if the benefits outweigh the costs.

But both your costs and your benefits likely contain some unknowns. Maybe you’ve added a placeholder of some kind for “employee satisfaction,” —  and now you need to compare that to the cost of hiring an HR director.

You can assign a monetary value to the unknowns to help with the comparison, but they’re still unknowns. To help this process, think about how confident you are with your assumptions. Do you have some data to back up the dollar amount associated with a particular benefit? Or was it mostly a guess?

When you consider the risk that your assumptions might be wrong, you’ll think about your comparison differently. The potential benefit might be huge (such as increasing market share), but it’s not a guarantee.

Making a decision and reviewing your assumptions

Cost-benefit analysis would be a lot easier if you could predict the future, wouldn’t it? Even with the unknowns, it’s still a healthy exercise. It forces you to list out costs you may not have considered or benefits that seem great on paper, but don’t stack up against the cost.

Over time, and as you make more complex decisions, you can revisit your past cost-benefit analysis reports and look for ways to improve. You’ll collect more data the longer you’re in business — about your employees, customers, product strategy, and operations.

For a young startup, many decisions may feel risky in the beginning. But they’ll get easier in the future, especially as you get more experience doing a cost-benefit analysis.

Keep in mind that a cost-benefit analysis is a good first step to understand what to prioritize project and investment-wise. From there, though, it’s just as important to have a framework for feature prioritization when planning your roadmap so that you can stay focused and make sure that your company is putting resources towards its most impactful projects.