Costbenefil analysis

Any project requiring an investment must, as a minimum, provide a greater benefit than putting that investment in. say. a bank.

The most common way of carrying out an economic assessment of a proposed information system, or other development, is by comparing the expected costs of development and operation of the system with the benefits of hav ing it in place.

Assessment is based upon the question of whether the estimated costs are exceeded by the estimated income and other benefits. Additionally, it is usually necessary to ask whether or not the project under consideration is the best of a number of options. There might be more candidate projects than can be undertaken at any one time and. in any case, projects will need to be prioritized so that any scarce resources may be allocated effectively.

The standard way of evaluating the economic benefits of any project is to carry out a cost-benefit analysis, which consists of two steps.

• Identify ing and estimating all of the costs and benefits of carrying out the project This includes development costs of the system, the operating costs and the benefits that are expected to accrue from the operation of the system. Where the proposed system is replacing an existing one. these estimates should reflect the costs and benefits due to the new system. A sales order processing system, for example, could not claim to benefit an organization by the total value of sales - only by the increase due to the use of the new system.

• Expressing these costs and benefits in common units We must evaluate the net benefit, which is the difference between the total benefit and the total cost. To do this, we must express each cost and each benefit in monetary terms.

Most costs are relatively easy to identify and quantify in approximate monetary terms. It is helpful to categorize costs according to where they originate in the life of the project.

• Development costs - include the salaries and other employment costs of the staff involved in the development project and all associated costs.

• Setup costs - include the costs of putting the system into place. These consist mainly of the costs of any new hardware and ancillary equipment but w ill also include costs of file conversion, recruitment and staff training.

Operational costs been installed.

consist of the costs of operating the system once it has

Many costs are easy to identify and measure in monetary terms.

Benefits, on the other hand, are often quite difficult to quantify in monetary terms even once they have been identified. Benefits may be categorized as follows.

• Direct benefits - these accrue directly from the operation of the proposed system. These could, for example, include the reduction in salary bills through the introduction of a new, computerized system.

• Assessable indirect benefits - these are generally secondary benefits, such as increased accuracy through the introduction of a more user-friendly screen design where we might be able to estimate the reduction in errors, and hence costs, of the proposed system.

• Intangible benefits - these are generally longer term or benefits that are considered very difficult to quantify. Enhanced job interest can lead to reduced staff turnover and. hence, lower recruitment costs.

Indirect benefits, which are difficult to estimate, are sometimes known as intangible benefits.

Brightmouth College are considering the replacement of the existing pay roll Exercise 3.1

service, operated by a third party, with a tailored, off-the-shelf computer-based system. I.ist some of the costs and benefits they might consider under each of the six headings given above. For each cost or benefit, explain how. in principle, it might be measured in monetary terms.

If a proposal shows an excess of benefits over costs then it is a candidate for further consideration.

Typically products generate a negative cash flow during their development followed by a positive cash flow over their operating life. There might be decommissioning costs at the end of a product's life

The difficulty and importance of cash flow forecasting is evidenced by the number of companies that suffer bankruptcy because, although they are developing profitable products or services, they cannot sustain an unplanned negative cash flow.

Any project that shows an excess of benefits over costs is clearly worth considering for implementation. However, as we shall see later, it is not a sufficient justification for going ahead: we might not be able to afford the costs; there might be even better projects we could allocate our resources to instead; the project might be too risky.

Project Management Made Easy

Project Management Made Easy

What you need to know about… Project Management Made Easy! Project management consists of more than just a large building project and can encompass small projects as well. No matter what the size of your project, you need to have some sort of project management. How you manage your project has everything to do with its outcome.

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