Cost-benefit analysis and accounting data

“Can we decrease the selling price of a product and stay profitable?” “Should we purchase a component part from a supplier in Mexico, Canada, China, or the EU, or should we manufacture it locally?" “How much would it cost us to manufacturer a product?” “What is the estimated profit of our North American division next year?” “How much in advertising expenditures can we budget for the next quarter?” “How much should we bid for a federal construction project?" “What is the anticipated cost of a litigation case?" … The list of questions managers face in their daily decisions is infinite. Managers are paid to manage people and make decisions. Many decisions are forward-looking and require an estimate of future benefits and costs. This is called a cost-benefit analysis. Often the cost-benefit analysis involves the comparison of a few alternative courses of actions, but sometimes it can be used to evaluate just one scenario.

1. Cost-benefit analysis: the trade-off perspective

Generally speaking, benefits represent an acquisition of something of a probable “value.” Thus, the types of benefits organizations may receive varies and depends on their mission: for some, amassing piles of cash is an ultimate goal while for other, in addition to some cash, serving the interests of a broad stakeholder group may be of value too (e.g., decreasing pollution, humanly treating employees and providing good working conditions and compensation).

While some benefits are direct in their impact on the organizational performance and position, others are indirect. For example, the training of employees costs organizations cash and time and lost opportunities from using that cash and time on other alternatives (aka, opportunity costs); such training may result in direct benefits such as increased employee efficiency and morale and indirect benefits such as increased customer satisfaction from improved products or services and increased sales.

For most organizations benefits represent the acquisition of tangible and intangible resources of probable value. Important to note, the word “probable” reminds us about the uncertainty about the value of a resource. The valuation of probable benefits is inherently subjective.

In order to receive a probable benefit, organizations must take action. All activities require a sacrifice of resources, which we call “costs.”  Costs can include both outlay costs (i.e., cash flows at some point in time) and opportunity costs (i.e., lost benefits from the alternative use of sacrificed resources). While the amount or type of resources sacrificed may be uncertain, there is certainty that there will be some sacrifice of resources in order to achieve a specific objective.

While the sacrifices of resources (costs) is mostly certain, the acquisition of benefits is uncertain. The trade-off between benefits and costs requires the evaluation of both projected benefits and anticipated costs to see whether a given course of action is beneficial or not at the net. This trade-off between resources often carries both short-term and long-term net effects that organizations need to anticipate. While some trade-offs are instant (e.g., received a patent but gave up cash for it), others play out in the long run (e.g., today invested in R&D that may result in cash sales in a few years).

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