A benefit–cost ratio (BCR) is an indicator, used in
cost–benefit analysis
Cost–benefit analysis (CBA), sometimes also called benefit–cost analysis, is a systematic approach to estimating the strengths and weaknesses of alternatives. It is used to determine options which provide the best approach to achieving benefits ...
, that attempts to summarize the overall
value for money
In economics, economic value is a measure of the benefit provided by a good or service to an economic agent. It is generally measured through units of currency, and the interpretation is therefore "what is the maximum amount of money a speci ...
of a project or proposal. A BCR is the ratio of the benefits of a project or proposal, expressed in monetary terms, relative to its costs, also expressed in monetary terms. All benefits and costs should be expressed in discounted
present value
In economics and finance, present value (PV), also known as present discounted value, is the value of an expected income stream determined as of the date of valuation. The present value is usually less than the future value because money has inte ...
s. A BCR can be a
profitability index in for-profit contexts. A BCR takes into account the amount of monetary gain realized by performing a project versus the amount it costs to execute the project. The higher the BCR the better the investment. The general rule of thumb is that if the benefit is higher than the cost the project is a good investment.
The practice of cost–benefit analysis in some countries refers to the BCR as the cost–benefit ratio, but this is still calculated as the ratio of benefits to costs.
Rationale
In the absence of funding constraints, the best value for money projects are those with the highest
net present value
The net present value (NPV) or net present worth (NPW) applies to a series of cash flows occurring at different times. The present value of a cash flow depends on the interval of time between now and the cash flow. It also depends on the discount ...
(NPV). Where there is a budget constraint, the ratio of NPV to the expenditure falling within the constraint should be used. In practice, the ratio of present value (PV) of future net benefits to expenditure is expressed as a BCR. (NPV-to-investment is net BCR.) BCRs have been used most extensively in the field of transport cost–benefit appraisals. The NPV should be evaluated over the service life of the project.
Problems
Long-term BCRs, such as those involved in
climate change
In common usage, climate change describes global warming—the ongoing increase in global average temperature—and its effects on Earth's climate system. Climate change in a broader sense also includes previous long-term changes to ...
, are very sensitive to the
discount rate used in the calculation of net present value, and there is often no consensus on the appropriate rate to use.
The handling of non-monetary impacts also presents problems. These impacts are usually incorporated by estimating them in monetary terms, using measures such as WTP (
willingness to pay
In behavioral economics, willingness to pay (WTP) is the maximum price at or below which a consumer will definitely buy one unit of a product.Varian, Hal R. (1992), Microeconomic Analysis, Vol. 3. New York: W.W. Norton. This corresponds to the st ...
), though these are often difficult to assess. Alternative approaches include the
UK's
New Approach to Appraisal
The New Approach to Appraisal (also NATA) was the name given to a multi-criteria decision framework used to appraise transport projects and proposals in the United Kingdom. NATA was built on the well established cost–benefit analysis and envi ...
framework.
A further complication with BCRs concerns the precise definitions of benefits and costs. These can vary depending on the funding agency.
[Porter, H. L., Neely, S. T., & Gorga, M. P. (2009). Using benefit–cost ratio to select Universal Newborn Hearing Screening test criteria. ''Ear and hearing'', ''30''(4), 447.]
Calculation
:
See also
*
Benefit shortfall
When the actual benefits of a venture are less than the projected or estimated benefits, the result is known as a benefit shortfall.
If, for instance, a company is launching a new product or service and projected sales are 40 million dollars per ...
*
Cost–benefit analysis
Cost–benefit analysis (CBA), sometimes also called benefit–cost analysis, is a systematic approach to estimating the strengths and weaknesses of alternatives. It is used to determine options which provide the best approach to achieving benefits ...
*
Cost overrun
A cost overrun, also known as a cost increase or budget overrun, involves unexpected incurred costs. When these costs are in excess of budgeted amounts due to a value engineering underestimation of the actual cost during budgeting, they are known ...
*
Business efficiency
The efficiency ratio indicates the expenses as a percentage of revenue (''expenses'' / ''revenue''), with a few variations – it is essentially how much a corporation or individual spends to make a dollar; entities are supposed to attempt minimizi ...
*
Price–performance ratio
Notes
References
*Jennifer Greene, Andrew Stellman(2007). "Head first PMP," ''O'Reilly'', (330)
{{DEFAULTSORT:Benefit-Cost Ratio
Transport economics