Benefit Cost Analysis Definations by ocak

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									Benefit/Cost Analysis (BCA) Definitions & Basic Directions
DEFINITIONS Note: All definitions from PENNDOT’s Benefit/Cost Analysis (BCA) course materials apply. A few are
provided here as a quick reference as well as supplemental definitions to aid in the use of the BCA spreadsheet.

Benefit – Any positive result of the implementation of an idea or project; may be tangible or intangible. If
quantitative, the data is keyed into the spreadsheet under ―BENEFITS‖.

Benefit/Cost Ratio (b/c ratio) – Total benefits over total costs; indicates whether benefits exceed costs over
the project life cycle. Can be used for comparison (higher ratio = better).

Net Present Value (NPV) = (PV of Benefits - PV of Costs). NPV is the discounted dollar value of
expected net benefits and is the standard method for deciding whether a project can be justified on economic principles. The NPV computation allows the reviewer(s) to identify the investment with the highest net return. A negative net return indicates that the investment cannot be justified based solely on financial benefits. To create an accurate picture of NPV, the benefits and costs across the entire useful life of the project must be included in the calculation. If the NPV is positive, the financial return on the project is considered acceptable. If the NPV is negative, the project warrants further review.

Payback Period = The number of years and/or months it takes for the benefits to payback the original
investment. Calculated by having the cumulated costs divided by the annual benefits till they are equal.

Present Value – Today’s dollar value of future benefits and costs. Present Value Tables – A table of varying Discount Factors is built into the Excel spreadsheet. Check with the OA/OIT for the most current discount rate to use at the time the project is analyzed. Return on Investment (ROI) = ((Present Value of Benefits / Present Value of Costs)/Present Value of
Direct Costs (see next paragraph)) multiplied by 100. ROI measures the percentage return of a particular investment. A ROI reflects a total return (or negative return) for investment dollars other than ―sunk costs‖. An example would be the costs for PENNDOT maintenance personnel would not go into the calculation for ROI since the salaries would be paid regardless (sunk cost) of whether the project is implemented. A negative ROI indicates that the investment cannot be justified based solely on financial benefits. For ROI, if there are acquisition costs (see below) for each fiscal year of the project, they should be input into the analysis. The Excel worksheet calculates ROI. Direct Costs = Capital Acquisition Costs + Acquisition Costs + Costs (Direct). Capital Acquisition Costs would be defined as the up-front dollars needed to launch a project (ex: Purchases of computers, printers, and software) Acquisition costs would be defined as Contractors (consultants) hired, facilities leased or purchased, etc. Costs (Direct) would be recurring costs (see next paragraph) for hardware and software maintenance, supplies, etc.

Recurring costs = any costs that should be budgeted and paid out in future years—consultant costs for maintenance, upgrades to software etc.

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Time Value of Money – The "time value of money" is the concept a dollar received today is worth more than
a dollar received at some point in the future; because the dollar received today can be invested to earn interest. Time value of money exercises generally involve the relationship between an amount of money, a period of time, and a rate of compound interest.

Data Collection & Input Basic Directions: BCA Benefit & Cost Data Input Worksheet – Provided within the IT project workbook, are BCA data
input worksheets (Customer / Stakeholder Benefits, Operational Benefits, etc.) The data input worksheets allow straightforward compiling/calculations of financial data. That data is used for input into the BCA Worksheet. This should be done electronically with all the requisite worksheets within the workbook for each project.

BCA Excel Worksheet- Use only one BCA worksheet within the workbook. The project useful live (years)
and discount rate may be modified in the appropriate cells within the sheet. Though not recommended unless necessary, benefit and cost subcategory titles may be changed as specific to each project. If no entry is required, just leave the cell(s) blank.

Category definitions: COSTS: Real or anticipated expenditures necessary to implement an IT project.
--Capital Acquisition Costs (Hardware/Equipment) – One time up front (non-recurring) expenditure for computers, printers, etc. used in setting up an IT project. --Capital Acquisition Costs (Software) – One time up front (non-recurring) expenditure for software used in setting up an IT project. --Acquisition Costs () – One time up front (non-recurring) expenditure for setting up an IT project. --Consultant Costs – Expenditure to engage a needed expert to complete an IT project. --Documentation Costs – Expenditure needed to record instructions for an IT project. --Facilities Costs – Expenditure needed to engage place of work to complete an IT project. --Training Costs – Expenditure needed to train personnel who would use the completed IT project. --Internal Information Systems Consultant Costs- Expenditure needed for consultants under contract to information systems bureaus or agencies. --Hardware Costs (Recurring) – Recurring expenditures for maintenance contracts for computers, printers, etc. --Software Costs – Recurring expenditures for software license renewals, etc. --Supplies – Expenditure needed for office supplies (paper, pens, tape, etc.) to complete an IT project. --Operations/Maintenance-Expenditures paid directly to an external entity to operate and/or continue to maintain an IT project. --Other Costs-Expenditures not previously listed and needs to be included to capture the costs of an IT project.

COSTS (Indirect):
--Bureau Personnel/ FTE Costs- Costs for the number of hours used by State employees (requesting organization/business owners) working directly on an IT project. -- Information Systems Personnel / FTE Costs- Costs for the number of hours used by State employees (internal Information Systems staff) working directly on an IT project. --Operations/Maintenance-Expenditures (allocated overhead attributed to State employees) to operate and/or continue to maintain an IT project. --Other Costs-Expenditures (not directly paid to an external entity) not previously listed and needs to be included to capture the costs of an IT project.

Disposal Costs: --Disposal Costs-Expenditures paid to dispose of acquired equipment and/or materials used to create and or maintain an IT project. 2

BENEFITS:
--Customer/ Stakeholder Benefits-Quantify the estimated annual value of the project to Pennsylvania citizen/customers. This includes the ―hard cost‖ value of avoiding expenses (―hidden taxes‖) related to conducting business with your agency. These expenses may be of a personal or business nature. They could be related to transportation, the time expended on or waiting for the manual processing of governmental paperwork such as licenses or applications, taking time off work, mailing, or other similar expenses. As a ―rule of thumb,‖ use a value of $10 per hour for citizen time savings and $.325 per mile for travel cost savings. --Bureau Personnel/FTE Cost Avoidance- An investment in future personnel associated with the IT project will not have to be made. This should be completed only if your operations costs are expected to be reduced. --Information Systems Personnel/FTE Cost Avoidance- An investment in future Information Technology personnel associated with the IT project (maintenance) will not have to be made. This should be completed only if your operations costs are expected to be reduced. --Operational Benefits- Savings generated by not expending funds for the cost of running a government operation (paper, electricity, office rentals, etc.). --Residual Value- recovered funds from the sale of equipment no longer used to maintain or support the original IT project. --Social / Environmental Impact Benefits- Quantify the estimated annual value of the project to Pennsylvanians for ―hard cost‖ value of avoiding expenses (―hidden taxes‖) related to the lowering of the quality of life due to detraining social or ecological nature. Examples would be lowering of crime, pollution, etc. As a general rule, these benefits must have solid basis in fact and be well documented. --Other Benefits- Benefits (revenues, savings, etc) not previously listed and needs to be included to capture the benefits of an IT project.

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1. Complete a BCA Benefit & Cost Data Input Worksheet (Customer / Stakeholder Benefits, Operational Benefits, Consultant Costs, etc.) for each benefit and cost of the project life. So projected financial data should be documented using a worksheet for each requisite benefit and cost. 2. Enter Quantitative data in the BCA spreadsheet.

DATA INPUT DIRECTIONS

NOTE: To obtain the greatest degree of objectivity and accuracy, retain a set of financial documents to support your analysis in the appendices.

I. Input Costs (Capital Acquisition, Acquisition costs, & Costs (Direct))
Costs from each BCA Data Input Worksheet should be entered in the cell for the appropriate project year. Project Total will be automatically calculated within the excel spreadsheet

II. Input Benefits (Projected or Actual Benefits)
Benefits (Savings) from each BCA Data Input Worksheet: entered in the cell for the appropriate project year. Project Total will be automatically calculated within the excel spreadsheet.

III. Run Calculation (Projected Cumulative total for ALL project years)
Calculations: All calculations are performed automatically within the excel spreadsheet.

IV. Evaluate the Data Total Net Present Value:
Higher Number = Better B/C Ratio: Greater than 1 = Project benefits Outweigh costs. Equal to 1 = Project benefits at least Match the costs.

Less than 1 = Project benefits do Not outweigh costs. ROI: (See ROI under definitions) Projected

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Using BCA Spreadsheet 1. Quantify Life Cycle
Step 1. Determine the life cycle of the project.  When does the project outcome become obsolete?  Indicate the appropriate Project Life (i.e., number of years) in cell D13 in the BCA Worksheet.

2. Quantify costs over the life cycle of the project.
Step 2. Estimate costs for the project.  What are the costs for the full life cycle of the project? Collect cost data in the Benefit & Cost Data Input Worksheet(s). Also, differentiate between upfront and annual costs.  Use the appropriate cells (color aqua blue) in the BCA Worksheet to record costs for the project.  Record the basis for cost estimates within the Benefit & Cost Data Input Worksheet(s).

3. Quantify benefits over the life cycle of the project.
3. Define and estimate the monetary value of benefits for each project alternative.  What are the tangible benefits for the project?  Consider internal and external customers/stakeholders.  What future costs (FTEs) will be avoided?  What savings are anticipated from improved operations?  What would be the value (residual) of the project at the end of its useful life upon termination/disposal?  What is the anticipated increase in service and/or products (to society/environment)?  Use the appropriate cells (color light green) BCA Worksheet to record monetary benefits for the project.  Record the basis for benefit estimates in appropriate worksheet(s)

4. Confirm Discount Rate
Step 4. Enter the Discount rate used for the project.  The discount rate used will be determined by OA/OIT.  Enter the appropriate Discount rate in cell D56 in the BCA Worksheet. (OA/OIT currently recommends 5%)

5. Review Calculated Totals.
Step 5. Confirm calculated totals make “sense” for estimated costs and benefits.  Confirm calculated totals appear for each year of the lifecycle of project.

6. Review Calculated Values.
Step 6. Confirm calculated values make “sense”  Total Net Present Value is in dollars (can be negative to positive).  B/C Ratio (ranges from less than to greater than 1)  ROI is the benefits over direct costs expressed as a percentage.  Payback Analysis will provide an answer in year(s) and percent of year. 5

REFERENCES

Cost/Benefit Analysis Handbook - Pub.348, Revised 10.97, PENNDOT Bureau of Fiscal Management. As a general reference, pages 19-24 provide definitions of terms used in the BCA. Particularly review ―Estimation of Costs and Benefits‖, pg. 20. Cost/Benefit Analysis Course – Written by Dering Consulting Group, 2004 for PENNDOT.

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