# How to Determine Whether the Cost-Benefit Ratio Is Positive or Negative

Strategic planning for every business leaders requires weighing the pros and cons of any new implementation. One of the metrics measures is the benefit cost ratio (BCR), also known as the cost benefit ratio. Learning to discern if the cost-benefit analysis formula leads to a positive or negative result is essential to understanding if a strategic plan is viable. Calculate the ratio by dividing the proposed benefits by the proposed costs of a project.

## Cost-Benefit Analysis Definition

The cost-benefit analysis reviews the overall value of a proposed project or initiative. Understanding the benefits of investing in a project is not always easily defined in revenues or monetary values. Some benefits are defined in qualitative terms, meaning how it impacts a specific community or group. When it comes to business strategic planning, a strategic plan often discusses the cost-benefit ratio in terms of a return on investments. If \$100,000 is spent and that yields \$500,000 in new revenues, there is a positive projected ratio, to proceed with the strategic plan or project.

But if the return is not in revenues, the analysis must revert to the mission of the organization proposing it and the resulting benefit. For example, if a city council proposes to invest \$100,000 in a new senior center, the value will not be seen in cost but in terms of building a community that helps keep retirees active and thus engaged. Anticipated returns could be viewed in lower medical costs or needs for support in other areas, but the overall objective of the plan is how many people will be served and how effectively: a qualitative review.

## Cost-Benefit Analysis Equation

The cost-benefit equation is simply the costs of the project divided into the anticipated returns. If the projected revenue is more than the projected cost, the ratio is positive. However, the formula for the cost-benefit analysis accounts for variables such as inflation and other discounting principals. Every project has a time frame required for implementation thus the only accurate ratio is one that considers discounting variables.

This is called the Net Present Value (NPV):

NPV = Value / (1 + r)^t

In this formula, NPV is the value that will be used in the cost-benefit ratio equation. Value is the of the benefits. The r is the discount rate and t is the time frame. The NPV is the value used as the projected benefit value using all factors to define it in real monetary terms.

## Positive or Negative Ratio

A ratio can be either positive or negative. If it is positive, the initiative is deemed worth the money invested. If it isn't, the project is deemed as losing money. When the ratio is less than one, it is negative. When it is one it is breaking even or neutral. If it rises above one, the project is making money and the ratio is positive.

## Cost-Benefit Ratio Example

A business looks to invest \$100,000 in a new product that it projects will yield \$500,000 in revenues, based on today's monetary values. It will take two years to create and inflation is estimated at three percent.

NPV = \$500,000 / (1 - 0.03) ^2

Thus, the Net Present Value is \$531,406. This means the cost-benefit ratio is calculated by the initial costs divided into this number. The result is a positive ratio: 5.31. If the NPV was less than the projected investment, the end cost-benefit ratio would be negative.

For example, if the NPV was calculated at \$98,000, the ratio would be 0.98. This means the program would lose \$2 for every \$100 spent. Business leaders would want to reevaluate the program.
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