When it comes to making an informed investment decision, one way is to use the benefit-cost ratio (BCR).

Benefit-Cost Ratio Defined

The BCR calculates how profitable a project’s (or an asset’s) cash flows are via a present value cash flow analysis. It takes the value of all incoming cash flows and weighs it against the same project’s or asset’s outgoing cash flows. If the calculation results in a BCR higher than 1, then more than likely that asset and/or project will provide a positive outcome.

How the Benefit-Cost Ratio is Calculated

=  ((Moneys received / 1 + discount rate) ^ Cash flow time frames)) / ((Moneys expended / 1 + discount rate) ^ Cash flow time frames))

Money received can also be referred to as the cash flows’ benefits. Money expended is also referred to as cash flow. This formula essentially divides the discounted cash flows by the discounted cash outflows. It’s important to mention that the discount rate can also be referred to as the business’s or investor’s required return.

The following is an example of the different levels of cash flows:

Based on the calculations, the following illustrates the results for both Discounted Costs and Discounted Benefits:

The final calculation sums up the Discounted Benefits and the Discounted Costs and then divides them, resulting in:

$135,612.32 / $59,735.54 = 2.27

Analyzing the Results

The resulting figure means that $2.27 is expected to be generated per $1 invested. It can be used by both internal stakeholders and potential external investors to gauge if the asset or project is worth the risk.

If the BCR came back at less than 1, it would indicate an Internal Rate of Return (IRR) that is lower than the discount rate. This reading would also show that the net present value of the project or asset is projected to be negative.

If the BCR is 1, this essentially means the net pre-set value is zero. The IRR would be equal to the discount rate.

If, however, the BCR is more than 1 – as in the example above – it means the IRR is higher than the discount rate, and the net present value is more than zero.

It’s important to consider that these are only assumptions. If, for example, the cash flow forecasting is incorrect or the discount rate is off, the ratio can provide wide variances.

Conclusion

Whether it’s an internal stakeholder or a potential investor, this ratio can and should be used as part of a holistic financial analysis program.

The Customer Acquisition Cost (CAC) measures how much a company spends to obtain new, additional customers. Oftentimes, it’s used with the customer lifetime value (LTV) metric, which also projects the customer’s profitability to calculate the newly acquired customer’s value.

It’s primarily used to measure a business’ sales and marketing departments to figure out their profitability, profit margin and return on investment figures.

How to Calculate

CAC = Sales and Marketing Expense/Number of New Customers

Where: Examples of the expenses include product and service promotion expenditures, special compensation and commissions, regular wage payments, and operating expenses.

The tally of newly acquired customers is simply how many new, unique contracts the business acquired. It’s important to keep the expenses and customer acquisition numbers consistent over the same periods.

Why It’s Important

Business owners and their managers, along with investors, can look at sales and marketing efforts from a return on investment on their expenditures and outcomes. For example, there could be multiple channels that sales and marketing utilize to obtain new customers over a quarter, half-year, or 12-month period (such as email marketing, social media marketing, conferences, etc.). Based upon each channel, the customer acquisition cost is determined by dividing the financial outlay per customer acquired.

From there, each channel can be analyzed to see which one works well and, equally important, which ones don’t work well and either need to be discontinued or modified. Internal stakeholders and external investors (both existing and potential) can look at trends to see if existing management is productive or needs to be replaced with more competent individuals.      

Accounting Considerations

Based on FASB’s Accounting Standards Codification 340-40, businesses are required to document and capitalize incremental costs of securing new customer business if the related expenses are projected to be recouped.

An incremental cost in the scope of obtaining a contract is a cost an entity incurs to obtain a contract that wouldn’t have been incurred if the contract hadn’t been obtained.

While a sales commission (be it fixed or a percentage of a new contract) may be considered an eligible incremental cost to one of its employees, it’s not necessarily always the case. Rather, the true test of whether an incremental cost is capitalizable depends on the subjective interpretation of whether a mandated financial expenditure for an incremental cost is attributed to signing a contract with a new customer.

The following sample situations often require more investigation to determine whether the capitalization of costs is applicable:

• Equity issuances based upon meeting production and essential function goals
• Employee compensation according to previous years’ executed contracts
• Sales commissions allocated over multiple time frames and/or to more than one employee for a single contract.

ASC 340-40 also stipulates the amortization schedule of capitalization costs of obtaining a customer contract on a scheduled timeline that follows the delivery to the customer of the contracted goods or services.

Conclusion

While the customer acquisition cost may be straightforward, when it comes to subjective cases, businesses that have experience with murkier situations are able to make the most of their subjective sales and marketing expenses when navigating the tax and accounting landscape.