Benefit to Cost RationIn finance there are very many terms that are used to describe a situation, comparison or analysis. Therefore, benefit to cost ratio is used to describe a financial comparison between production of goods in a firm and expenditure burden experienced when making a product. Evaluation is hence mandatory to analyze whether venture is profitable or the converse. Thus when the expenditure exceeds other parameters then the business is more of a time waster than a profit making organization. In this event it is litmus test of cost-benefit analysis which depicts the significance of money spent.
It can also be described as a ratio between the costs and benefits or returns which are in monetary terms. It is mostly used in cost-benefits appraisal. The peek net present value of money is seen in most firms with the absence of funding constraints. In the presence of a budget constraint Net Present Value versus the costs incurred within the allocated constraint is mainly applied. Under normal circumstances the ratio of Present Value of the projected profits in a goal oriented firm is usually seen and evaluated as a Benefit-cost ratio (Charlotte, 2010).
Emergence of benefit to cost ratioThe concept was first introduced by a French engineer (Jules Dupuit) in the early 18th century. The formula was further updated by an economist which became the foundation of benefit to cost ratio. However to was not brought into use until the implementation of the Federal Navigation Act. The act was targeted at engineers who were with projects in the United States are worth more to the public than the injected capital in the business projects.
The ratio however should be in the present monetary values discounted. This was thus very handy to the general public as the families of the affected individuals were far more secure than the actual project. The Act was in this way a life saving move to the public (Boardman, 1996). Technique of calculatingThere are various techniques of calculating the Benefit to Cost Ratio. For instance in an organization which is of course profit making business say a beverage making firm. Note the amount of money obtained through selling the product over a certain period of time.
For example the firm makes £567,000 in a gross period of six months for selling the beverage. Hence the benefits or returns would be £567,000. Afterwards figure out the amount of expenditure so far experienced during the same time. Say the firm incurred £100,000 for the product to be worthy to the clients, this includes the promotion of the products and other miscellaneous costs i. e. rental fee, labor services, transport cost, security and purchasing of raw material. The expenditure is hence £100,000.
Therefore divide the total returns and the expenditure so far incurred. That is £567,000 by £100,000. Results obtained will in this way be 5.67 which are approximately 6. Hence the conclusion made would be the benefit to cost ratio is 6-to-1 or alternatively 6:1 (Charlotte, 2010). AdvantagesUsing the ratio it facilitated the business to know the merits and demerits of both extreme ends i. e. profit and loss. In creation of a proposal it would show what the firm is oriented to. It is very simple to make ones own analysis with the application of the formula.
Though there are other considerations that make the determination of this hard such as production line breakdown and employee performance and output. This would cause a dramatic alteration on the ratio. This should be taken into account when formulating a good proposal of the firm. The beverage firm showed a profitable future since the output exceeded the input showing positive future. For the business to stay afloat it should maintain a positive ratio to cater for its needs and any eventuality ahead (Cohn, 1972).