Q. What do you mean by cost and benefit analysis? What are the different type of cost and benefits?
The costs associated with the system are expenses or losses arising from developing and using a system. But the benefits are the advantages received from installing and using this system. Cost/Benefit analysis is a procedure that gives a picture of the various costs, benefits and rules associated with a system.
Cost and Benefit Categories (CBA)
In performing CBA it is important to identify cost and benefit factors. Cost and benefits can be categorized into the following categories.
It is the money, spent on the people involved in the development of the system. These expenditures include salaries, other benefits such as health insurance, conveyance allowance, etc.
Expenses incurred during the preparation of the physical site where the system will be operational.
These can be wiring, flooring, acoustics, lighting, and air conditioning.
Operating costs are the expenses required for the day to day running of the system. This includes the maintenance of the system. That can be in the form of maintaining the hardware or application programs or money paid to professionals responsible for running or maintaining the system.
These are variable costs that vary proportionately with the amount of use of paper, ribbons, disks, and the like. These should be estimated and included in the overall cost of the system.
We can define benefit as
Profit or Benefit = Income - Costs
Benefits can be accrued by :
- Increasing income, or
- Decreasing costs, or
The system will provide some benefits also. Benefits can be tangible or intangible, direct or indirect. In cost benefit analysis, the first task is to identify each benefit and assign a monetary value to it.
The two main benefits are improved performance and minimized processing costs.
Further costs and benefits can be categorized as
Tangible or Intangible Costs and Benefits
Tangible cost and benefits can be measured. Hardware costs, salaries for professionals, software cost are all tangible costs. They are identified and measured. The purchase of hardware or software, personnel training, and employee salaries are example of tangible costs.
Costs whose value cannot be measured are referred as intangible costs. The cost of breakdown of an online system during banking hours will cause the bank lose deposits. Benefits are also tangible or intangible. For example, more customer satisfaction, improved company status, etc. are all intangible benefits.
Direct or Indirect Costs and Benefits
From the cost accounting point of view, the costs are treated as either direct or indirect. Direct costs are having rupee value associated with it. Direct benefits are also attributable to a given project. For example, if the proposed system that can handle more transactions say 25% more than the present system then it is direct benefit.
Indirect costs result from the operations that are not directly associated with the system. Insurance, maintenance, heat, light, air conditioning are all indirect costs.
Fixed or Variable Costs and Benefits
Some costs and benefits are fixed. Fixed costs don't change. Depreciation of hardware, insurance, etc are all fixed costs.
Variable costs are incurred on regular basis. Recurring period may be weekly or monthly depending upon the system.
Fixed benefits don't change. Variable benefits are realized on a regular basis.
Performing Cost Benefit Analysis (CBA)
Steps of CBA can briefly be described as:
- Estimate the development costs, operating costs and benefits
- Determine the life of the system
- When will the benefits start to accrue?
- When will the system become obsolete?
- Determine the interest rate
- This should reflect a realistic low risk investment rate.