Section 4: Cost Analysis

What is Cost Analysis?

Cost analysis is a process of gathering and organizing information about the costs of a program as a basis for making decisions. In its simplest form, cost analysis consists of the following:

• Listing all of the ingredients required to produce a program,
• Specifying the amount of each ingredient used,
• Identifying or estimating the unit cost of each ingredient, and
• Calculating the total costs of the program based on this information.

Often cost analysis is expanded beyond this simple framework in two ways. One is to allocate costs to various program components or activities so that how and where resources are being used can be better understood. The other is to allocate costs based on who provides the resources or pays for them in order to better understand who bears the cost burden.

Some form of cost analysis is regularly conducted for every program. Annual budgets have to be prepared, and expenditures accounted for and balanced with the available budget. Unfortunately, in many cases the routinely available cost data do not provide an accurate or adequate basis for decision making. Cost data are typically reported in line-item budgets that provide no information on the relationship between costs, program activities and outcomes. One of the most valuable uses of cost analysis is to reorganize budget information around organizational and program missions and their outcomes. Cost analysis will often use accounting data, but it is not accounting. Its primary focus is on the actual ingredients, or resources, used and the (potential) alternative uses of those resources. However, the costs of important resources do not always appear in the organization's budget. Costs may be paid for by another organization. Costs may not appear in any current budget because they are past (facilities that were built long ago) or future (retirement pay for active duty personnel) costs. On the other hand, some budget items may not be viewed as costs at all (for example, staff or facilities that are dedicated to specific purposes and can not be reallocated to other uses). Whether or not a budget item is viewed as a cost depends on the cost analysis framework setup, and that depends on the decisions under consideration.

The key to understanding cost analysis in contrast to accounting is the view that the cost of any resource is its "opportunity cost." Most resources have alternative uses. The true cost of using a resource in a given way is the lost opportunity to use it in another way. From this perspective, whether or not the organization pays for a resource, how it pays, and how much it pays may be irrelevant in assessing the true cost. This is not to say that organizations do not care whether and how much they pay for resources. These are important matters, and in many cases what is paid for a resource may indicate how much it costs the organization (but not always). For example, most agencies impose costs on their clients-client time may be spent in travel, in waiting, or in participating in a service. This time is not free; it is a cost to the client, and it may be a cost to the client's employer.