Decisions make or break startups. So how do you decide whether or not to attempt that project with a lucrative markup? How do you decide between two different alternatives? Who should i marry July or Emily? Turns out that you can analyse the costs and benefits of your decisions, within a “Rough” framework to arrive at answers that make a little sense. The answers however are dependent on some of your assumptions about the variables within the frame work.
Standard Cost Benefit Analysis
In standard cost benefit analysis all one needs to do is make assumptions of the costs and benefits of a particular course of action.
For example if you want to do a cost benefit analyses for project X
Operating costs (Cost of resources used for project): 2000$/month
Fixed cost (Cost Of Project acquisition): 1000$
Opportunity Cost (Cost for opportunities you missed): 1000$/month
Project Revenue: 7000$
Now Net Benefit/Cost (-) = (7000) – (2000*months + 1000*month + 1000)
If months = 1, then net benefit is 3000$ so you go ahead and take the project.
If months = 3, then net cost is 3000$ so you donâ€™t take the project.
This is the bare minimum cost-benefit analysis framework.
Cost benefit analysis for geeks
Ok now onto the geek flavor of cost benefit analysis. This is something i developed and use, so pls do point out any mistakes you can find. Anyway the crappy thing about the above frame work is that there is no flexibility. Your guess for the fixed costs might be wrong and hence your whole analysis might be screwed. So in my framework i make room for uncertainty in the guessed values.
So instead of saying my fixed costs will be 1000$
i’ll say my fixed costs could be 1000$ with 80% probability, 2000$ with 15% probability and 4000$ with 5% probability.
So now the above equation becomes
Cost (-)/benefit = 0.8*((7000) – (2000*months + 1000*month + 1000)) + ((7000) – 0.15*(2000*months + 1000*month + 2000)) + 0.05*((7000) – (2000*months + 1000*month + 1000))
Hence the framework becomes.
Cost (-)/Benefit = (benefit1 – cost1)*Probability Of Outcome1 + …….. + (benefit n – cost n)*Probability Of Outcome n
The above two frameworks are only for cost-benefit for a project with a one time payoff.
What if the decision to be taken requires investment and the Return on investment is expected after many years? All you need to then is to use the time value of money paradigm, which is described in my post startup valuation for geeks.
So if you see any mistakes or have any doubts please do leave a comment. Bye
PS: I know the post sucks and is humor less but lately my cost benefit analysis shows that its costlier for me to write a long post with attempts at slapstick.