Difference Between Cost Effectiveness Analysis and Cost Benefit Analysis?

Key Difference – Cost Effectiveness Analysis vs Cost Benefit Analysis
 

The key difference between cost effectiveness analysis and cost benefit analysis is that cost-effectiveness analysis compares the relative costs and outcomes (effects) of a project whereas cost benefit analysis assigns a monetary value to the measure of the effect of a project. The use of these two techniques largely depends on the nature of the project and the type of industry.

CONTENTS
1. Overview and Key Difference
2. What is Cost Effectiveness Analysis
3. What is Cost Benefit Analysis
4. Side by Side Comparison – Cost Effectiveness Analysis vs Cost Benefit Analysis
5. Summary

What is Cost Effectiveness Analysis?

Cost effectiveness analysis is used as an evaluation tool where outputs produced by a project are not measured in monetary terms. This approach is widely used in health and pharmaceutical industries where the benefits are qualitative in nature rather than quantitative. For instance, in health research, the important yardsticks for success criteria are aspects such as the illnesses prevented and years of life gained where the measures will be cost per illness prevented and cost per year of life gained, respectively.

The underlying concept of cost effectiveness analysis is that a project or an investment, even though it may be expressed in monetary terms, should not be assessed for its monetary value alone and qualitative factors should also be considered. A ‘cost effectiveness ratio’ can be calculated as per below.

Cost Effectiveness Ratio = Cost of Investment / Outcome of Investment

Figure 01: Cost Effectiveness Analysis is widely used in health and pharmaceutical industries.

What is Cost Benefit Analysis?

Also referred to as ‘benefit cost analysis’, cost benefit analysis is a systematic process by which business decisions are analyzed. The benefits of a given situation or business-related action are summed, and then the costs associated with taking that action are subtracted. Cost benefit analysis is a compromise between the additions of costs and benefits to implement a business decision. The decision-making criteria will be to proceed with the investment if the benefits overweigh costs.  Cost benefit analysis does this by quantifying the costs of a project in monetary terms and comparing them with the benefits, also expressed in monetary figures.

All direct and indirect costs, as well as recurring and nonrecurring costs, should be considered and care should be taken to not underestimate costs or overestimate benefits. In addition, the following costs should be considered as well.

• Opportunity cost of the project (potential benefit foregone by investing funds in an alternative investment)
• Cost of not doing the project
• Potential costs of project failure

However, it should be noted that cost benefit analysis is a simpler investment analysis tool and is only suited for small to medium scale investments that span over a limited time period. Due to complexity and uncertainty of cash flows, this cannot be considered as an appropriate decision tool for large-scale projects that span over an extended time period.

Figure 02: General steps in cost benefit analysis

What is the difference between Cost Effectiveness Analysis and Cost Benefit Analysis?

Cost Effectiveness Analysis vs Cost Benefit Analysis
Cost-effectiveness analysis is a form of economic analysis that compares the relative costs and outcomes (effects) of a project.	Cost benefit analysis assigns a monetary value to the measure of the effect of a project.
Nature of Evaluation
Cost effectiveness analysis is a mixed (quantitative and qualitative) project evaluation technique.	Cost benefit analysis is a quantitative project evaluation technique.
Usage
Cost effectiveness analysis is suitable for service related organizations, especially for ones in healthcare sector.	Cost benefit analysis is suitable for evaluating highly technical and industrial projects since monetary values can be easily assigned to such projects.
Opportunity Cost
Cost effectiveness analysis generally does not consider opportunity costs.	Opportunity cost should be taken into account in cost benefit analysis.

Summary – Cost Effectiveness Analysis vs Cost Benefit Analysis

The difference between cost effectiveness analysis and cost benefit analysis mainly depends on whether the focus is given to the value of output (in cost effectiveness analysis) or the monetary value (in cost benefit analysis) of a project. Cost benefit analysis is widely used in business organizations due to its inherent commercial nature while service related organization can widely benefit from the use of cost effectiveness analysis.