The interim Blues manager wanted to snap up his compatriot during his time in charge at Anfield but was unable to persuade Villarreal to sell the playmaker, who eventually signed for Arsenal from Malaga last summer.
"The chairman there [at Villarreal] wanted to keep the team and didn't want to lose one of his best players," Benitez told reporters. "It wasn't possible to sign him, because it was a big risk with the amount of money we had to spend.
"At the time he was a winger and not playing between the lines or as a second striker. We knew he could be a great player, but he was [going to cost] too much at the time and we could not afford him.
"To come to England and settle down is not just down to the quality of the player but sometimes it also depends on the environment and, in the case of Cazorla, he is doing well at Arsenal."
Benitez's Chelsea side has struggled at home in the Premier League of late, only winning one of its last seven games to fall 13 points behind league leader Manchester United. The manager argues that a derby against a side such as Arsenal is the perfect tonic after Wednesday's 2-2 draw at home to Southampton, though.
"After a draw at home, we have a top side coming to us and that is good for us," Benitez said. "It gives us extra motivation, and we will be focused. This is different from a normal game because the atmosphere is different."