Cost analysis is one of four types of economic assessment (in addition to cost benefit analysis, cost effectiveness analysis, and cost utility analysis). As the name implies, cost analysis focuses on the costs of implementing a program regardless of the primary outcome. Cost analysis is an important first step before undertaking any other economic assessment to determine the suitability or reliability of a project.
Step
Part 1 of 3: Defining Goals and Scope
Step 1. Know why a cost analysis is needed
The scope of the cost analysis will depend on these reasons so before considering the scope of the analysis, you need to make sure that the results of the cost analysis will answer your main question.
- If you are doing a cost analysis just to prepare a budget or plan for the future, the scope is usually only at the organizational level.
- On the other hand, for a more narrow and specific purpose, such as determining the feasibility and cost of a particular service, it may require a more narrow cost analysis that is only aimed at certain services.
Step 2. Identify your cost analysis point of view
In addition to why you need a cost analysis, you also need to know “whose” costs need to be analyzed. This determines the data to be collected and how to classify it.
- For example, maybe you want to calculate the cost of offering a particular service to a client. If so, look at costs from his point of view, and consider the amount of service fees charged (or will be billed), transportation to location, and other costs.
- If you just want to know the cost of a program, you will generally look at company expenses. You may also be looking at opportunity costs, such as whether offering one program prevents you from offering another.
Step 3. Diversify the programs offered
The way you describe the program will determine how the cost allocation will be analyzed. If the organization runs programs that are easily distinguishable, the division can be clearly seen. For overlapping programs or programs that share the same resources, determine how to separate them.
- Overlapping programs can be lumped together to some degree, instead of being assessed separately. Choose the most logical way according to the organization's operations, and try to work as efficiently as possible.
- To determine whether programs need to be disaggregated, look at the services each program offers, the resources required to deliver the services, and to whom the services are provided. If 2 out of 3 of these factors are the same in the two related programs, you can combine them in a cost analysis.
Step 4. Determine the time period you want to assess
How you classify and calculate costs depends on the time period for which the costs are analyzed, such as long term (several months or years) or short term (several weeks or just once).
- For example, if you are trying to determine the feasibility of a particular service, first determine how much it would cost to produce that service. You will perform a long-term cost analysis to determine if the organization can afford the costs of the service.
- It's usually better to choose a time period that will allow you to get accurate revenue data, rather than just estimates. This is helpful if you plan to use cost analysis as the basis for further economic evaluation.
Part 2 of 3: Classifying Costs
Step 1. Review previous cost analysis reports, if possible
If the organization has already conducted a cost analysis, apply the same or a similar way of classifying costs. This way, the two reports can be compared, making them more useful over time.
You could also try looking at cost analyzes that similar organizations do or offer the same services
Step 2. List all direct costs of the program being evaluated
Direct costs include salaries and benefits for team members, raw materials and supplies, and any necessary furniture or equipment. Depending on the type of program or service offered, you may also incur contract, license, or insurance fees.
- Direct costs are costs specifically incurred for programs or services that are evaluated in a cost analysis. This fee is not shared with other programs.
- Overhead costs, such as utilities (including water and electricity), can be direct costs if the program or service has its own location.
Step 3. Indirect costs
Indirect costs include general administrative expenses or management salaries and allowances, facilities, equipment, and anything else that some other program or service contributes to. What is classified as an indirect cost will depend on how you separate the programs or services the organization offers.
In particular, when calculating a separate program or service, you need to allocate these indirect costs
Step 4. Arrange costs to reflect the purpose of the analysis
The cost analysis report should ultimately be useful to the organization. Instead of relying on broad financial categories, choose categories that accurately reflect the objectives of the cost analysis.
Standard categories can be personnel costs, operating costs, and start-up costs. Within each category, identify what costs are classified as direct and indirect costs
Part 3 of 3: Calculating Costs
Step 1. Collect financial reports and information
For each type of cost that is planned to be included in the analysis, note the sources of data needed to be able to calculate the associated costs. If you want to estimate costs, create a list of reports that contain the information needed so that you can make reliable estimates.
- Use actual cost information as much as possible. This will increase the reliability and usefulness of your cost analysis.
- For estimates, look for reliable sources that can be applied as narrowly as possible. For example, if you need to estimate pay, use the average rate for employees within a city, rather than a national one.
Step 2. Total the direct costs of the program
Using the information that has been collected, add up the expenses for salaries, equipment, raw materials, and other costs directly related to the program under review. Extend these costs over the time period analyzed.
- If you are doing a long-term cost analysis, calculate the direct costs first on a weekly or monthly basis, then extend them.
- When you calculate personnel costs, be sure to include the cost (or value) of the benefits provided to employees working in the related program.
Step 3. Allocate indirect costs to the analyzed program
To allocate indirect costs, determine how each cost can be divided between several programs. After that, calculate the proportion of costs in related programs.
For example, let's say you allocate the HR director's salary. Since this director is responsible for program personnel, it is natural for his salary to be divided according to the number of employees on the staff. If you have a total of 10 employees, and 2 are delegated to the program or service under review, you can allocate 20 percent of the director's salary to the program in a cost analysis
Step 4. Calculate the depreciation of the asset
If the organization's capital assets, including furniture or equipment, are to be used to implement the program or provide the service being evaluated, the depreciation of the asset must be included in the total cost of the program or service.
Calculating depreciation can be difficult. If you are not experienced in depreciating assets, we recommend using the services of an accountant
Step 5. Consider hidden costs
Depending on the organization and program being evaluated, there may be additional costs that do not appear on the budget or financial history. Include these cost estimates in the analysis so that the results are more credible.
- For example, if you're doing a program cost analysis for a foundation, the hidden costs could include the estimated value of volunteer hours, donated raw materials, or donated space.
- Hidden costs can also include opportunity costs. For example, launching one program may affect an organization's ability to offer other programs.
Step 6. Draw conclusions based on your findings
Go back to your goal of conducting a cost analysis and determine the action that needs to be taken. You can also include projections or estimates of future costs associated with the program or service.
- At a minimum, your cost analysis will provide an actual cost figure for running a particular program or service.
- Your cost analysis may also raise new questions, indicating further analysis is needed before making a final decision.
