STEPS IN COST ANALYSIS
This table seeks to map out the basic steps in cost analysis, taking into account simple financial analysis,
cost efficiency analysis and cost effectiveness analysis. It is important for managers to know what has to
happen in terms of process and to be able to critically appraise a cost analysis.
State the problem/
situation
What is the purpose? What cost-related questions need to be answered? The
questions will dictate decisions on the cost analysis approach taken (financial
analysis, cost-efficiency, cost-effectiveness) but also will guide how costing is
done.
Define the
programme to be
analysed
To ensure that cost analysis is both comprehensive and relevant, a clear
description of the programme is essential, including: well-defined outcomes and
the corresponding expected outputs and activities (i.e. a programme logic model),
the historical development, level of operations (what happens at local, district, and
central levels), and sources of funds.
The more precise the statement of expected outcomes and outputs, the easier it
will be for measurement of benefits for cost-efficiency and cost-effectiveness
analysis.
For cost-efficiency analysis, the description will focus on the outputs analysed, but
should situate these in their broader programme context.
Define measures
For cost-efficiency
analysis: output
measures
For costeffectiveness
analysis: outcome
measures
For costeffectiveness only:
Identify alternative
ways to achieve
outcomes
For cost-effectiveness analysis, care must be taken when there are multiple
expected outcomes. A choice must be made between focusing only on one
outcome, carrying out a separate analysis for each major outcome or weighting
each outcome so that a combined score can be obtained.
The challenge in this is to ensure that the effects being measured are the results of
the resource inputs whose costs are being calculated.
Be aware that choice of indicators is complex, especially at the outcome level.
While many criteria or indicators may be explored and discussed with key
stakeholders, particularly for cost-effectiveness analysis where alternatives are
compared, there must be agreement on how benefits are defined. (See also core
content sheet “Selecting indicators: criteria”.)
The complexity of effectiveness measures is guided by the intended use and
scope of the cost analysis. Cost-effectiveness analysis in large national and
regional studies with a view to influencing major national policy decisions — for
example studies supported by the World Bank — will involve complex efforts to
quantify benefits, though still without attaching a monetary value. For example,
benefits of health interventions might be quantified in terms of their impact on
quality of life and expressed in terms of quality-adjusted life year.
At least two alternative ways to achieve the defined objectives are suggested for
comparison. A single cost-effectiveness result on its own says very little.
Alternatives may stem from proposed solutions to a particular problem or question,
e.g. should we pursue vertical vaccination campaigns or vaccination through
integrated primary health care services. Alternatives may be hypothetical, in which
case costs will have to be estimated with reference to examples in other contexts.
It is important to consider a range of alternatives to avoid missing the best option.
Eliminate options that:
 are clearly less efficient based on rough calculation of costs and effects
 are not feasible in technical and political terms
 are too costly given existing budget constraints
 can’t be analysed easily, without excessive cost or in time to influence decisionmaking.
Costing - Page 1/4
Develop a costing
framework
The categories used for cost analysis should flow from the questions you are trying
to analyse. A combination of categories is usually used. These may include:




Input types (recurrent costs and capital costs)
Source of funding (foreign, national, etc.)
Level of operation (field and headquarters)
Activities — one way of categorising within activities is to distinguish primary
activities (i.e. front-line contact with primary stakeholders), secondary (i.e.
providing technical support to primary), and ancillary activities (i.e. general
support to programme).
If the programme model described above links activities to outputs and outcomes,
and cost can be assigned to specific activities, it is then possible to do costefficiency and cost-effectiveness analysis.
Identify and
measure costs
This entails defining and measuring financial and economic costs and can be
broken down into four sub-steps, the latter three dealing with economic costs.




Assess and draw from available financial data. This may require reconciling
more than one set of accounting records. It also requires reconciling data from
different organisations that may handle costing issues differently. Budget
records will reveal at least financial recurrent costs. They may not provide
appropriate data for calculating capital costs (accounts register purchases, and
do not track use). They might exclude important off-budget recurrent costs,
e.g. donations or for personnel things like subsidised transportation and
housing.
Calculate the annual value of capital goods. Equipment, vehicles, and
buildings can be purchased in one year and “consumed” or used over several.
Their annual value, including depreciation, should be taken into account.
Calculate the value of off-budget recurrent costs. Costing should include
resources used by the programme but not paid for, such as voluntary work and
in-kind donations. They have zero financial value but do have an opportunity
cost. This is an important area for taking into account costs to primary
stakeholders.
Allocate shared costs. Accounting data may not disaggregate all data to the
activity or even programme level. Major capital costs – vehicles, buildings,
large expensive equipment – may be shared across activities and
programmes. Calculating how much of the total cost to allocate to the activity
or programme requires either direct measures of use (observation or journals)
or indirect measures, e.g. the cost of personnel management services might
be based on the percentage of staff used by the activity or programme.
How this data is collected will include the obvious review of financial records at
central levels with partner organisations, but also often at different levels of
programme operation. It may also include observation of different stages of the
programme at different operation levels, interviews, focus groups, surveys.
In cost-effectiveness analysis, this is done for each alternative. The cost and
effectiveness measures must be linked for each alternative studied; use consistent
categories for costing.
Identify and
measure benefits
For cost-efficiency analysis this refers to the outputs.
For cost-effectiveness analysis, it requires measuring the effectiveness of each
alternative.
…
Costing - Page 2/4
Summary
calculations
With the data collected, it is then possible to build cost profiles for the different
activities and programmes analysed.
For both cost-efficiency and cost-effectiveness analysis, calculations will include
establishing the unit/cost per benefit (be it output or outcome).
It is important to also identify the “marginal costs” (defined as the change in total
cost resulting from the production of one more unit of output or outcome). If a
programme doubles the results, the costs are not necessarily doubled. Economies
of scale may allow more users for decreasing cost per user. Calculating marginal
costs allows us to take this into account.
Good analysis will also explore the significance of assumptions about some
variables, the exact values of which are uncertain. These variables can be related
to either costs or effectiveness. Cost analysis will have required defining a
plausible range of values for that variable and then making a best estimate.
Testing should involve exploring the effect on final calculations if that estimate is
doubled or halved. A report should indicate which assumptions and corresponding
estimated values have a significant effect on the final calculations and conclusions.
Further analysis
Having established basic conclusions about unit/cost, the next step is to explore
what is responsible for the differences among alternatives studied. Following are
some of the issues that should be explored:
In examining the cost profiles, which input categories are significantly different (in
percentage of the total cost)? What explains those differences and what relation
does this bare on results achieved? For example, consider prices paid for inputs,
staff ratios, staff productivity, degree of use of a facility. What if anything can be
done to lower these costs?
Analysis should also explore economies of scale (cost savings due to larger
capacity of facility), and economies of scope (cost savings from the use of one
facility for a greater diversity of services). What would happen to costs if the
activities or programmes were scaled up or down, or piggy-backed with other
services? Some care must be taken in this analysis, as changes in results might
not be neatly calculated.
It is also important to analyse the different conditions under which alternatives
were operating, i.e., geography, population distribution, and other variables. Do
any of these help to explain the differences in cost effectiveness? For example,
providing water services may be necessarily more costly in one region than
another due to terrain, depth of aquifers, etc.
Try to identify the key stages in the transformation process for the programme. At
which stages do the differences between the alternatives become obvious? For
example, what best explains the differences in cost effectiveness of different
sanitation technologies: the differences in the functioning, frequency of use, or
quality of use of the sanitation alternatives? This might point to areas for change in
programming.
In cost-analysis of humanitarian action, additional considerations include:
The need for speed must also be factored into analysis. Needs can be urgent for
immediate delivery of goods to save lives and higher costs can be justified
(Hallam, 1996:19).
Costing - Page 3/4
PITFALLS AND TRAPS

Is the scope of cost analysis cost-effective? Invest the greatest effort into finding (and using)
information on the bigger costs. In a more detailed cost-effectiveness analysis this means focusing on
the largest input categories instead of smaller, less important categories; e.g. on smaller categories, use
simple rules of thumb, like assuming building operating costs to be equal to a certain small percentage of
their annual capital (space) costs. Having limited cost analysis resources may mean analysing only the
highest cost aspects of a programme or sector effort; e.g. in a humanitarian response, focusing on
supply delivery for food programmes.

Is data collection efficient? Collect cost information at the highest level at which it is available (if of
reasonable quality) to minimise time and expense.

Is there double counting? Double counting the same elements (inputs) is especially risky when
obtaining data at more than one level; for example, staffing or salary figures at the delivery unit and
higher levels will likely overlap.

Is the use of market prices appropriate? Many goods are likely to be regularly traded in markets at
well-known and predictable prices and they can usually be valued at their market prices. However,
market costs do not always reflect “real” costs. Adjustments may be necessary, for example, where
shortages or difficulties in the supply chain might increase the costs. Market costs themselves may vary
considerably by region (e.g. housing and transportation costs) and it may be necessary to distinguish this
in data collection and calculations.

From whose perspective are costs calculated? Market costs may not reflect ‘real’ costs to all
stakeholders. The market value of a day labourer’s time may not reflect the opportunity cost in terms of
lost opportunity in other livelihood activities. One person’s cost might even be another person’s benefit.

Is quality of inputs taken into consideration? Since the quality of inputs may be related to prices, it is
important to ensure that a constant level of quality is compared across interventions. In principle, best
practice standards, can assist in controlling for quality differences in the analysis.

How solid are indirect measures? Some costs might require indirect, complicated and somewhat
subjective calculations. Previous studies estimating values for these can provide guidance. It is
important to establish how significant the assumptions on these indirect measures are to the final
conclusions. (See above, under “Further analysis”)
Sources: Brenzel, L. (1993); Hallam (1996); Kee, 1997:470; Phillips, M. and Huff-Rousselle, M. (2001); Rossi, P. H.,
Freeman, H. E. & Lipsey M. W. (1999); Thompson, M. S. (1980); Valadez J. and Bamberger M. (1994).
Costing - Page 4/4