Benefit Cost Ratio
In its simplest form, benefit cost ratio is a figure that is used to define the value of a project versus the money that will be spent in doing the project in the overall assessment of a cost-benefit analysis. This ratio provides a value of benefits and costs that are represented by actual dollars spent and gained. By definition the benefit cost ratio should be expressed using present values that are discounted.
Benefit Cost Ratio Formula
To create a benefit cost ratio example we’ll use Widget Corp. as our fictitious business. Widget Corporation’s top account executive has an idea for a new widget that will revolutionize the widget industry. The total cost to plan, develop and produce the widget is $55,000. Once the production line has been set up, the revolutionary widget sells like hotcakes and produces record net profits for Widget Corp. of $500,000 for the year. Using the formula listed above, we can figure the benefit cost ratio.
500,000/55,000 = 9.09
The final outcome of $9.09 is the dollar representation of a $9.09 return for every $1.00 invested in the revolutionary widget. After one year of sales, the revolutionary widget paid for itself almost ten times.
Benefit Cost Ratio Analysis
Using the benefit cost ratio allows businesses and governments to make decisions on the negatives and positives of investing in different projects. In other words, using benefit cost ratio analysis allows an entity to decide whether or not the benefits of a given project or proposal outweigh the actual costs that go into the creation of the project or proposal.
Benefit cost ratio is simple enough to figure out, however, there are benefit cost ratio calculators available that take into consideration other factors that make the calculation a bit more complex. Factors such as actual employee production or production line breakdowns can cause the benefit cost ratio to change dramatically and so they must be accounted for when delving into the details of a particular proposal or project.
Businesses and governments can benefit greatly by figuring out the cost of a project versus its returns. For this reason alone, the benefit cost ratio is an important formula to be used in the decision making process for any project that might be presented.