General Scope Document: Cost Benefit Analysis

This is the final installment for the general scope document (GSD) series. Next month’s article will review a case study that highlights the importance of a GSD. The 11th step in a GSD is the cost benefit analysis (CBA). A CBA is a strategy for evaluating the potential for a project within the confines of a company. The purpose of a CBA is to ascertain if executing the project or operation is feasible, given the current circumstances of the company/operation. CBA in project management is an important tool in your GSD toolbox. This one has been devised to evaluate the cost versus the benefits in your project proposal. It begins with a list. There is a list of every project’s “estimated” expense and the benefits of successfully executing the project. From that, you can calculate the return on investment (ROI), internal rate of return (IRR), net present value (NPV) and the payback period. The difference between the cost and the benefits will determine whether action is warranted or not. The primary purpose for using a CBA is to determine if the project is sound, justifiable and feasible by figuring out if its benefits outweigh costs. However, it can also be used to offer a baseline for comparing projects by determining which project’s benefits are greater than its costs.

The Cost Benefit Analysis Process

The CBA process dates to 1848. French engineer Jules Dupuit outlined the 10-step process in an article as follows:

1. What are the goals and objectives of the project? The first step is perhaps the most important step because before you can decide if a project is worth the effort, you need a clear and definite idea of what it should accomplish.
2. What are the alternatives? Before you can know if the project is right, you need to compare it to other projects and see which is the best path forward.
3. Who are the stakeholders? List all stakeholders in the project.
4. What measurements are you using? You need to decide on the metrics you’ll use to measure all costs and benefits. Also, how will you report on those metrics?
5. What is the outcome of costs and benefits? Look over what the costs and benefits of the project are and map them over a relevant period.
6. What is the common currency? Take all the costs and benefits you have collected and convert them to the same currency to make an apples-to-apples comparison.
7. What is the discount rate? This will express the amount of interest as a percentage of the balance at the end of a certain period.
8. What is the net present value of the project options? This is a measurement of profit calculated by subtracting the present values of cash outflows from the present values of cash inflows over a period.
9. What is the sensitivity analysis? This is a study of how the uncertainty in the output can be apportioned to different sources of uncertainty in its inputs.
10. What do you do? The final step after collecting all this data is to make the choice that is recommended by the analysis. The entire team should be part of the decision-making.

Is the CBA Accurate?

That is the million-dollar question. Throughout my career, I’ve been asked on many occasions upon completion of a system assessment, failure analysis, energy study, etc.: What is your level of confidence in your findings? My standard answer is “it is as accurate as the data provided by plant personnel, DCS and historical data. For the purposes of a CBA, it is as accurate as the data you put into the process.” A word of caution: It is wise to be conservative with your estimates. I would not want to be the team leader sitting in front of management explaining why the project fell short on ROI. So, there you have it—the 11 steps of a GSD. You can see how each step complements another step in the process and the importance of each step in the development of the GSD. A solid GSD takes much of the uncertainty/guesswork out of the bidding process once the project is released to the engineering, procurement and construction (EPC) firm or engineering design firms. Next month, a case study.