Cost-benefit analysis explained
A cost-benefit analysis (CBA) helps evaluate proposals using a systematic method, which entails comparing all the expected benefits and costs of a project or policy in monetary terms, to determine if the benefits outweigh the costs.
CBAs are widely used, which makes it important that non‑economists understand what a CBA involves, and also what its key strengths and limitations are. This article reviews what a CBA is, outlines its key strengths and limitations, and explains how to use a CBA wisely, based on our extensive expertise in undertaking CBAs for a wide range of projects.
What is a CBA
A CBA is a decision-making approach that identifies and compares the benefits and costs of a policy or project in dollar terms. At its core, a CBA asks: Do the benefits of a project or policy exceed its costs?
In practice this requires identifying all the impacts of the project or policy, ranging from direct financial benefits and costs to broader social or environmental benefits and costs, and then assigning each a monetary value. The results of a CBA are summarised using net benefit (total benefits minus total costs) or a benefit-cost ratio (benefits divided by costs). A benefit-cost ratio above one indicates that the benefits outweigh the costs.
Key strengths of a CBA
The key strengths of undertaking a CBA for organisations are:
Evidence-based decisions: A CBA converts data and analysis into decision-making. By quantifying expected impacts, it replaces guesswork or intuition with a structured, systematic evaluation. This leads to informed choices based on the estimation of the expected net impact (positive or negative) of different options
Common metric for comparison: By expressing financial, social, and environmental outcomes as a monetary metric, a CBA allows an “apples-to-apples” comparison of different impacts. This makes trade-offs more understandable to decision makers
Transparency and accountability: The CBA process requires analysts to explicitly list all assumptions, data, and valuation methods used to estimate costs and benefits. This transparency helps stakeholders to see why and how a decision is reached. A well-documented CBA can justify that a project is worthwhile (or not) by showing the calculations behind a recommendation, which is important when seeking funding approval
Consistency in evaluation: Using a CBA provides a consistent framework through which to evaluate different proposals under the same criteria. Commonly used tools, such as Treasury’s CBAx model, promote uniform methods and values for analysis, ensuring that every project or policy is assessed on a level playing field.
Using CBAs wisely
Like any other economic modelling tool, CBAs have limitations. These are the limitations that organisations using a CBA should be aware of:
Not all benefits and costs are easily monetised: The dollar value of intangible or non-market impacts (environmental, public health, or cultural values) is often estimated, but these estimates are less precise and are routinely debated. However, if they are excluded, or undervalued, a CBA would give an incomplete picture of a project’s impact
Emphasis on quantifiable outcomes: The focus of a CBA on quantifying outcomes means it typically enhances those outcomes that can be measured in dollar terms. This “what gets measured gets managed” approach can lead to a narrow focus, such as prioritising short-term economic gains while discounting long-term or qualitative outcomes
Distribution of impacts is overlooked: A single net benefit figure does not identify who benefits and who bears the costs. A CBA might show a positive net benefit, even if costs fall on one group and benefits accrue to another group. CBAs focus on efficiency, not on how benefits and costs are shared across different communities or groups
Reliance on assumptions and data: CBA results are only as reliable as the data and assumptions behind them. Different assumptions can significantly change the outcome. Sensitivity analysis is critical to test the robustness of results when there are changes in key assumptions.
Despite these limitations, CBAs remain a cornerstone of sound economic decision making in New Zealand. They provide a disciplined approach to assessing whether proposals are likely to deliver net benefits. However, a CBA is not a crystal ball. It is only as good as its inputs and assumptions.
BERL’s extensive experience
At BERL, we are able to use our extensive experience with CBAs, across a wide range of sectors and project types, to work with our clients to maximise the benefits of CBAs and to mitigate the limitations of the approach. An example of one of our latest pieces of work can be found here: