Methods of Evaluating Financial, Economic and Social Benefits and Cost of Projects - Essay Example

Methods of Evaluating Financial, Economic and Social Benefits and Cost of Projects and Project Alternatives Name Institution Tutor Date Introduction Numerous projects fail, and billions of dollars are often lost on different projects every year. Thus, there is a crucial need to improve different ways of managing projects. The actual truth is that the best way of obtaining successful project is learning from previous activities. A retrospective method should be deployed to evaluate the performance of various projects, extract various lessons and make sound recommendations for future projects. The proposed analysis should considers three different measures, whether the project came on time, whether the project came as specified in the budget and whether the requirements of the project were obtained. This paper explores several methods of evaluating financial, economic and social benefits and cost of projects and project alternatives considering their advantages and disadvantages. Cost Benefit Analysis Cost-benefit analysis is a method utilized in determining the net benefits accumulating in the society due to projects policy or program. More often, cost-benefit analysis is conducted from of local point of view. The methodology can as well be performed in principle from the perspective of the region, local community and state. However, such constrained approach is not common (Commonwealth of Australia 2006). The suitable period for conducting cost-benefit analysis is usually the projected time of the program or the project. The methodology of cost-benefit analysis consider the stream of the cost and benefits of real resources and excludes for instance subsidies and taxes which are seen as transfer payments from one point of the society to another point. Moreover, cost-benefit analysis aims at measuring the value of benefits and costs resulting from the project. The method encompasses all cost and benefits which are not priced and are considered not to be the actual subject of market transactions (Boardman et al. 2006). Cost-benefit analysis is a critical tool in evaluating a project. The method determines whether a given project produces net returns. Use of funds may be efficient in obtaining the objectives of the project, but may still provide a negative return to the society if the profit from these targets is seen to be less than the cost involved. On the other hand, the project could obtain a positive return for the society but fail to achieve the goals of a given project (Adler and Posner, 2006). Advantages of cost-benefit analysis Cost-benefit analysis is essential in determining whether the program or the project will improve or worsen off the wider community. It determines whether the net effect of the program is positive or negative. Some of the major advantages of cost-benefit analysis are analyzed below. Cost-benefit analysis assists in making meaningful comparisons Cost-benefit analysis makes it easy to compare various proposals from different locations. However, a risk may arise when decisions are based on results from studies that do not have a common framework of assumptions or objectives. Provided there is a common base; cost-benefit analysis can be very efficient for decision makers. For instance, road improvement proposals can be compared with a plan to improve hospital, rails, in spite of significant institutional and technological difference that exist within their contexts (Commonwealth of Australia 2006). Cost-benefit analysis is essential to good program management The main idea behind cost-benefit analysis is that it often reflects the value of the project or program to the society. As a result, the value of the project to major stakeholders will also be calculated. For instance, in performing an assessment of rehabilitation activity, the value of the beneficiary of the activity will be identified either with regard to their personal well-being, long-term life earnings or any other important factor. For further illustration, in assessing a planned extension of a national park, it will be appropriate to determine the value placed on the project by those individuals who lose or benefit from the project. Cost-benefit analysis can lead to proper and sound program or project management since it is concerned with competency and is focuses on the priorities of major stakeholders (Commonwealth of Australia 2006). Cost-benefit analysis has a distributional impact One of the main advantages of cost-benefit analysis is that it offers a quantitative measure of the net profit of a program, enabling express comparisons between different projects. Cost-benefit analysis entirely provides the size of the benefits and losses for the impacted groups or persons. This information is vital in the public sector since it helps in making sound decisions and needs to be made clear since it is essential in identifying the individual who is likely to benefit or loose from a project or a program (Commonwealth of Australia 2006). Cost-benefit analysis is critical to assessment strategy A meticulous process of evaluation should be based on numerous lines of proof. The conclusions are more rigorous and more reliable if the assessment process encompasses several discrete data. The cost-benefit analysis emphasizes on quantification of costs and gains on a similar basis. Thus, it is an essential methodology to add to assessment strategy which encompasses other techniques as well (Commonwealth of Australia 2006). Cost-benefit analysis promotes clear thinking on the real value added Cost-benefit analysis offers an estimate of the worth of a project and the accompanying estimates that will happen when the proposal is lacking. The difference between the values may be viewed as value added from adopting the project. For instance, given that the gains of a new overseas marketing campaign to improve Australia as a vocational destination are approximated regarding new guests attracted to Australia. It is important first to estimate the number of guests who are likely to be attracted in Australia in the absence of marketing advertisement (Commonwealth of Australia 2006). Disadvantages of cost-benefit analysis In spite of several advantages posed by cost-benefit analysis, the technique also faces certain limitations which hinder its effectiveness. The limitations are discussed below. Market imperfections Cost-benefit analysis operates efficiently in competitive markets that have several buyers and sellers where none of them is at a position of dominating the market. However, it is not easy to meet this condition. There exist monopolies and several government interventions which interfere with the market, this may ultimately affect a project. Thus, adjustment in market prices should be undertaken before they are used for cost-benefit analysis (Nordic Council Of Ministers 2007). It is difficult to quantify intangibles When using cost-benefit analysis, it is difficult to quantify the value of immeasurable items. Approximations are often made yet they do not provide an accurate presentation of the actual value of the items. Thus, when using cost-benefit analysis, the use of assumptions, value judgments are often used. This renders quantification of intangibles susceptible to the violation (Nordic Council Of Ministers 2007). Financial Evaluation Financial evaluation is often performed from individual company or enterprise perspective rather than from the viewpoint of the whole society. The technique is concerned with evaluating the effects of a project on the firm’s financial performance. The technique is effective in answering the question as to whether a given proposal provides an acceptable return from a firm’s point of view. Financial evaluations may also be utilized for other reasons like estimating the least cost procurement scheme. In financial evaluation technique, it is only cash flows in and out of the firm that is considered. The cash flows from other parties are not included. In contrast to cost-benefit analysis, relevant money values encompass the impact of subsidies and tax on the relevant organization. The key examples of financial statement analysis include cash flow statements, balance sheets, and income statement. All these financial statements are often analyzed to help in the economic decision making of the organization (Commonwealth of Australia 2006). Main differences between financial evaluation and cost benefit analysis are illustrated in the table below Financial analysis Cost benefit analysis perspectives Agency/organization/ firm Society/economy Objective Analysis of the net financial effect of the proposal on the firm Maximising social returns to the economy’s resources Pricing Market prices Opportunity cost Transfer payments: Taxes subsidies Included Included Excluded Excluded Income distributional effects Excluded Noted but not incorporated Externalities Excluded Included Interest and depreciation Excluded Excluded Advantages of financial evaluation The first advantage of financial evaluation is that financial statement offers clear, coherent and objective information about the firm’s position including how much the firm owes and earns. This clear and objective information is important in making financial decisions like when to lower costs and when to expand the business. The firm may also decide to consider various intangible variables like quality of life issues impacting workers and employers (Commonwealth of Australia 2006). Another advantage of financial evaluation is its relevance. The analysis offers information which is directly related to the financial health of the firm and the capability of the firm to start new ventures. The amount of money an individual has in the bank is directly related to the decisions made by the firm. Thus, the firm is able to make sound decisions using its financial statement analysis. Moreover, financial analysis simplifies various financial statements and helps in highlighting vital information in a straightforward and easy form. A user of financial analysis can be able to judge a firm by viewing few figures rather than reading the entire financial statements of the organization ( Hitchner, 2011). In addition, financial analysis informs about sales pattern. The statements describe the amount of money the firm makes in a single year. The sales may vary; however; financial planners should be in a position to identify one pattern over several years of sales. For instance, the organization may have a pattern of improved sales when a new brand is released. The sales may also decline after a year or so. This is beneficial to the firm since the managers know when the sales are likely to rise and when they fall thus making sound sales decisions (Hitchner, 2011). Disadvantages of Financial Evaluation The first disadvantage is that financial analysis may provide the owner with a false sense of security, thus hindering the proactive development of the project. For instance, the financial statement of the firm may indicate that the firm is making enough profit which can make it improve its bottom line. The information may look good on paper, but the profit and earnings may rely on various unsustainable business models like selling firm inventory which cannot be replaced easily. In addition to various financial analysis statements, business decisions need to be based on immediate observations of various business activities (Myers, 2007). Additionally, the single financial statement only illustrates the condition of the firm at a single time. The statement does not indicate whether the firm is making profit or losses than the prior year. For instance, if the manager decides to use financial statements to make decisions about the future of the firm, they need to use various financial statements from previous years for them to acquire an overall image of the performance of the organization in the market. The financial statement needs to be a continuous analysis. It is inappropriate to use single statement in making decisions within the organization (Myers 2007). The table shows a simple financial evaluation form. Cost-Effectiveness Analysis Cost-effective analysis helps in formulating the cost of attaining a particular target. Cost effective analysis can be undertaken from a local and national perspective. Cost-effectiveness analysis is different with cost-benefit analysis since benefits are often represented in physical units but not in money terms. Again, alternatives assessed in cost effectiveness must be alike in nature. The cost-effective analysis is crucial in projects that concern areas such as education, health and accident safety where it is simple to compute gains in physical terms. Cost-effectiveness analysis is useful when the gains of the proposal are difficult to formulate in monetary units (Dean et al. 2006). Conducting cost-effectiveness analysis entails identifying the gains relevant to a project; such gains are often expressed in physical terms. Cost-effectiveness of a project is considered by calculating cost effectiveness ratios. The most efficient ratio is calculating the average rate per unit of effectiveness (Commonwealth of Australia 2006). It can be indicated as shown: CE= C/E Where CE= cost effectiveness C= cost (in dollars) E= Effectiveness Managers may however be fascinated to find out whether the new project is preferable to maintaining the existing project. If this is the case, they can use incremental cost-effectiveness ratio (Commonwealth of Australia 2006). ICER is represented as follows: ICER= Change in cost/change in effectiveness Cost effectiveness is high when the ratio is small. Cost-effectiveness ratio can be calculated for every project. After calculating cost-effectiveness analysis of a project, every project is ranked from the lowest ratio to the highest ratio (Commonwealth of Australia 2006). Advantages of cost-effective analysis Cost-effectiveness analysis is necessary for comparing various interventions with the other, specifically if the researchers want to make a comparison different projects for the same ailment or compare varied interventions for various ailments. Cost effective analysis is more useful in relating various projects that focus on the same goal. In the event of limited resources, it is vital to use them in a more cost effective way. For instance, assuming one has ten million dollars and has two project options to spend the cash, cost effective analysis helps by illustrating the best choice to invest the cash (Neumann 2005). Consequently, for one to use information about the cost effectiveness of prior interventions in most pleasurable manner, it is vital to consider how prices, epidemiology or demographics will vary in specific regions. It is appropriate to consider whether the project targets the main causes of disease in the country or decide if the proposal is practical based on prior establishment and experience. Additionally, one can assess cost effectiveness by considering how the project is implemented and distribution of items. Through reviewing of evidence, countries and organizations can tremendously improve their programs since the results and expense of various options will be outlined clearly. Disadvantages of cost-effective analysis There are some drawbacks and limitations to cost-effective analysis, one of the main problems of cost effective analysis is associated with its use of ratio measure. In cost-effectiveness analysis, prediction of effectiveness and costs lead to wrong outcomes. This results due to the use of ratio measure. As a result, sensitivity analysis may be utilized by researchers to investigate the distribution of cost effective ratio about the normal distribution. Additionally, cost-effectiveness analysis can be easily applied to qualitative and quantitative issues; however, it is more challenging to use cost-effective analysis to ecological issue (Neumann 2005). Moreover, it is difficult to quantify many options physically. This makes certain options to be omitted from the analysis or be estimated wrongly, as a result leading to biases in the final result. Cost effectiveness is often used to measure alternatives with the same scope. The methodology cannot be used to analyze projects with varied objectives or for a single program with several objectives. Conclusion It is important to conduct an evaluation to various project and project alternative to come up with sound decisions. There are three primary methodologies which are used in evaluating financial, economic and social benefits and cost of projects and project alternatives. Such method includes cost-benefit analysis, financial evaluation, and cost-effectiveness analysis. The three methods vary in their evaluation technique. The approaches are imparative in accessing the success of the project or the program. However, the methodologies also have certain drawbacks that should be taken into consideration for effective implementation of the strategies. References Adler, M. D., & Posner, E 2006, New foundations of cost-benefit analysis, Cambridge, Mass, Harvard University Press Boardman, A., Vining, A. Greenberg, D., and Weimer, D 2001, Cost-Benefit t Analysis: Concepts and Practice, Prentice Hall, Upper Saddle River, N.J, Commonwealth of Australia 2006, Introduction to Cost-Benefit Analysis andAlternative Evaluation Methods.pdf Dean T. J, Breman G., Measham, Alleyne G., Mariam Claeson, Prabhat Jha, Mills A., Musgrove P 2006 "Cost–Effectiveness Analysis." Priorities in Health, ed. , 39-58, New York: Oxford University Press. Hitchner, J. R 2011, Financial valuation: applications and models. Hoboken, N.J., Wiley. http://public.eblib.com/choice/publicfullrecord.aspx?p=661530. Myers, J 2007, A strategic, fundamental, and financial evaluation of Pacific Sunwear of California, Inc Neumann, P. J 2005, Using cost-effectiveness analysis to improve health care: opportunities and barriers, Oxford, Oxford University Press Nordic Council Of Ministers 2007,Nordic guidelines for cost-benefit analysis in waste management, København, Nordisk Ministerrådet Read More