Have you ever heard of the term Benefit Cost Ratio? This term becomes an investment analysis that helps you assess the feasibility of an investment project.
This analysis is often used by government projects for development, such as the MRT project. There are sacrifices, such as flooding because the main road is disrupted by construction or congestion due to MRT construction.
Even though there are sacrifices, why are you still building the MRT? Of course, because it has the benefits of the MRT which has more advantages than disadvantages.
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Then, what are the benefits and calculation formula of the benefit cost ratio?
Definition
Benefit cost ratio or B/C Ratio is a method of calculating the comparison between production costs and the benefits of a business project. Where ‘B’ is a benefit or advantage, while ‘C’ is a cost or cost.
Mathematically, BCR is calculated by dividing the present value of benefits by the present value of costs. If the BCR calculation result is greater than 1, it means that the expected benefits exceed the costs incurred, and the project is deemed worthy of investment.
Conversely, if the BCR is less than 1, it indicates that the costs of the project exceed the benefits generated, and the project is considered economically unviable.
Calculation Formulas
The following formula calculates the benefit cost ratio:
B/C Ratio = Total Revenue (FI) / Total Production Cost (TC)
There are indicators that can show the amount of profit of a business project. These indicators include:
- If the B/C Ratio is more than 1, then the benefits of the project are greater than the expenses so that the project is acceptable or feasible to continue.
- If the B/C Ratio is less than 1, then the benefits of the project are less than the expenses, so the project is not feasible and needs to be reviewed.
- If the B/C ratio is equal to 1, then profits and expenses are said to be balanced or break even
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Benefits of Benefit Cost Ratio
The benefits of BCR in making investment decisions are as follows:
1. Project Feasibility Evaluation
BCR assists in evaluating the feasibility of a project by providing a clear picture of whether the expected benefits will be able to offset the outgoing costs.
However, if the BCR is greater than 1, it indicates that the benefits of the project exceed the costs and the project can be considered worthy of investment.
2. Comparison of Investment Alternatives
Furthermore, BCR also compared several investment alternatives. When there are several possible projects, BCR is used as the primary comparison tool.
Projects with a higher BCR are considered more profitable and more worthy of investment than projects with a lower BCR.
3. Efficient Use of Resources
When conditions with limited resources, BCR helps identify projects that provide the greatest benefits at the most efficient cost.
This enables proper allocation of existing resources to achieve optimal results.
4. Data Driven Approach
Meanwhile, by carefully analyzing the expected benefits and costs, BCR helps reduce uncertainty in making investment decisions.
A data-driven approach helps decision makers to make more objective and informed decisions.
5. Economic Impact Evaluation
The existence of BCR helps in calculating economic benefits which include increased revenue, reduced operational costs , increased efficiency, and social impacts that may occur.
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6. Improving Investment Decisions
The BCR also helps identify projects that have the potential to provide high returns on investment and avoid unprofitable investments.
In addition, BCR helps promote better investment decisions.
Overall, BCR is an important tool in investment analysis that helps in evaluating project feasibility, selecting investment alternatives, efficient allocation of resources, and making more informed decisions.
How to calculate the Benefit Cost Ratio
Suppose we buy a copier for Rp. 1,000,000. Over a 5 year period, the project is expected to provide benefits in the form of revenue of IDR 300,000 per year.
BCR calculation steps are as follows:
1. Calculating the Present Value of Benefits
Assuming revenues occur annually for 5 years, it is necessary to calculate the present value of each year using the relevant discount rate. Suppose the discount rate used is 8% per year.
Using the present value formula for each year:
PV = CF / (1 + r)^n
Where PV is the present value, CF is the cash flow (revenue) for the year, r is the discount rate, and n is the year.
Calculating the present value of each year:
PV Year 1 = Rp300,000 / (1 + 0.08)^1 = Rp277,777.78
2 = Rp300,000 / (1 + 0.08)^2 = Rp257,201.65
3 = Rp300,000 / (1 + 0.08)^3 = Rp237,785.17
4 = Rp300,000 / (1 + 0.08)^4 = Rp219,432.82
5 = Rp300,000 / (1 + 0.08)^5 = Rp202,035.16
2. Calculating the Present Value of Costs
The total project cost is $1,000, so we need to calculate the present value of the cost using the same discount rate.
Using the cost present value formula:
PV Cost = Cost / (1 + r)^n
Where PV Cost is the present value of the cost, Cost is the project cost, r is the discount rate, and n is the year.
Calculation of the present value of costs:
PV Cost = Ro1,000,000 / (1 + 0.08)^1 = Rp925,925.93
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3. Calculate BCR
BCR = (PV Year 1 + PV Year 2 + PV Year 3 + PV Year 4 + PV Year 5) / PV Cost
= (Rp277,777.78 + Rp257,201.65 + Rp237,785.17 + Rp219,432.82 + Rp202,035.16) / Rp925,925.93
= Rp1,194,232.58 / Rp925,925.93
= 1.29
The BCR value is 1.29 which is more than 1, so that the investment in buying a copier is feasible and profitable for the company or business.
Accounting Software as a Benefit Cost Ratio Solution
As previously explained, the benefit cost ratio is an analytical method for projecting profits from a business project. The existence of this method to be able to calculate revenue and production costs per year.
The results of this method can also see how much profit is multiplied and the decision to continue the business project or not.
It would be nice if this method was also equipped with other analyzes to produce more accurate data.