How do people make and stick with financial decisions? The idea of weighing certain financial investments to determine which is best might feel overwhelming to many people. Even certain financial teams or planners still struggle with making the smartest fiscal decisions.
Making big investment decisions gets even harder when there are larger markets or economies dependent on the decisions you’re making. The pandemic has been a perfect example of how challenging making and sticking with financial decisions can be. Everything from deciding which patients get ventilators to which businesses receive government funded cash support is a financial decision, and hours of thought go into making each of those decisions.
Making the right business decision involves the analysis of hundreds of factors. You have to look at available resources, the current state of the economy, the availability of your workforce, your customer base, and your expected profit margin. You also have to consider the cost of stocking your inventory, potential market downtrends, and the long-term costs associated with beginning a specific project. This analysis is known as a cost-benefit analysis, and it’s one of the key tools businesses use to make financial decisions or investment decisions.
Cost-benefit analysis can be thought of as a math equation or a weighing of the scales. On one side, you stack all the advantages of a certain financial decision including potential income, and on the other all the costs and revenue loss potential. This provides a neutral framework to approach making your decision. Let’s take a look at this in a practical context:
A company is deciding whether to open a new location in a local shopping center. Their investors ask for a cost benefit analysis to help them determine whether this new investment would be smarter for the company long-term. The team’s development team comes up with the following:
Costs:
- Additional rent, insurance, and utility payments
- Hiring new staff and increasing overhead employment costs
- Increase in inventory expenses
- Opening in competitive market with already established vendors nearby
- Spreading company resources thin
Benefits:
- Increasing customer base
- Moving more inventory and widening sales
- More marketing and advertising exposure in busy shopping center
- Scaling growth upward plants seeds for more development and distribution options
Many business analyses will also factor in something known as opportunity cost. Opportunity cost refers to the loss of the benefits that you could gain by choosing a different alternative, or the things you miss out on because of the decision that you make and stick with. In our example, that would look like the benefits the company might get by reinvesting the money they’d spend on their new location back into their current location. Things like improved inventory quality, better employee benefits, and more inventory options are considered opportunity cost because you will have lost out on those benefits if you choose a different opportunity, such as opening a new location.
Throughout the pandemic, businesses and governments have been running cost-benefit analyses and opportunity cost formulas to help guide important medical and fiscal decisions. Cost-benefit analyses can be used to make almost any decision: for example, which patient gets an ICU bed or which doctor receives new personal protective equipment. It’s also used to guide fiscal policy as governments try to keep local economies afloat. Cost-benefit analysis is a smart fiscal tool that can help make smart financial decisions and will play a large role in stabilizing a post-pandemic economy.
