Cost Benefit vs Cost Effectiveness
Cost benefit analysis and cost effective analysis are both tools used for decision making and help in evaluating a project/investment/course of action in terms of either their feasibility and profitability or value and effectiveness. Cost benefit and cost effectiveness also allow decision makers to compare alternatives and select the best course of action. Despite their similarities, these two methods of analysis are different in terms of what they measure and how. The following article explores each concept in detail and highlights their similarities and differences.
What is Cost Benefit Analysis?
Cost benefit analysis is a tool used in finance to determine the costs and benefits involved in carrying out a project, in making decisions, or following a specific course of action. A cost benefit analysis can be done by adding up all the benefits or revenues that will be obtained in the future if the project is followed (could also be a business decision, investment, or business related activity) and reducing all the potential costs that would result from the project. Once the expected costs are reduced from the expected benefits, a net value can be calculated which will help businesses make a decision as to whether the course of action should be followed or not.
Cost benefit analysis can be done to evaluate whether the project is feasible, profitable, and can also be used to compare between alternative projects to select the best option. A cost benefit analysis can be used by an individual, corporation, government, or anyone for that matter, and its most common use is in financial decision making.
What is Cost Effectiveness Analysis?
Cost effectiveness analysis evaluates the costs that are to be incurred in order to obtain a greater benefit that usually is not measured in monetary terms. A cost effectiveness analysis will require the decision makers to make a judgment by looking at the value and effectiveness of the outcome that was obtained by spending money. Cost effectiveness analysis is very commonly used when evaluating healthcare benefits, for which often times a monetary value cannot be assigned. For example, the value/effectiveness of lengthening a life through the distribution of an expensive drug cannot be measured in terms of money.
Cost effectiveness in the context of business could mean taking actions that improve the value and effectiveness with things like avoiding wastage such as replacing energy wasting machines with more efficient alternatives, targeting advertisements to the right audience instead of general advertising, and maintaining an efficient productive workforce.
Cost Benefit vs Cost Effectiveness Analysis
Cost benefit analysis and cost effectiveness analysis are both used in decision making, to determine whether a specific project, investment, decision, or course of action should be followed through. Despite the fact that the two terms are quite interconnected to one another, they are different in terms of what they measure, the contexts in which they are used, and the measure of benefit that each employ.
A cost benefit analysis measures the net value (benefits minus costs) in monetary terms and is used mostly in evaluating business related activities to which a monetary value is easily assigned. In cost effectiveness analysis, the value or effectiveness of the course of action is measured and is used mostly in healthcare and public benefit where a monetary value cannot be placed.
Summary:
• Cost benefit analysis and cost effectiveness analysis are both used in decision making to determine whether a specific project, investment, decision, or course of action should be followed through.
• A cost benefit analysis can be done by adding up all the benefits or revenues that will be obtained in the future if the project is followed (could also be a business decision, investment, or business related activity) and reducing all the potential costs that would result from the project.
• Cost effectiveness analysis evaluates the costs that are to be incurred in order to obtain a greater benefit that usually is not measured in monetary terms.