When a business owner makes a decision to invest resources in a project, they usually think about the explicit costs, which are the costs that are easily measurable and can be directly attributed to the project. However, there is another type of cost that is just as important, but often overlooked: implicit costs. Implicit costs are costs that are not directly measurable or visible but are still incurred as a result of a decision. In this blog post, we will define implicit costs, explore the different types of implicit costs, and explain why they are important for business owners to consider.
What are Implicit Costs?
Implicit costs, also known as opportunity costs, are the costs associated with the next best alternative that is forgone as a result of choosing a particular option. These costs are not directly visible and cannot be measured in monetary terms, but they are still very real and can have a significant impact on a business’s profitability.
For example, imagine that a business owner decides to invest in a new product line. The explicit costs of this investment might include the cost of raw materials, labor, marketing, and distribution. However, there are also implicit costs associated with this decision. These might include the revenue that the business owner could have earned by investing in a different project, the time and energy that the business owner could have spent on other activities, and the risk associated with the investment.
Types of Implicit Costs
There are several different types of implicit costs that business owners should consider when making decisions:
- Foregone Revenue: This type of implicit cost refers to the revenue that could have been earned if the business owner had chosen a different option. For example, if a business owner decides to invest in a new product line, they might forego the revenue that could have been earned by expanding into a new market or launching a new advertising campaign.
- Opportunity Cost of Time: The opportunity cost of time refers to the value of the time that the business owner or employees spend on a particular project. If a business owner spends all of their time developing a new product line, they might miss out on other opportunities to grow the business.
- Risk: Investing in a new project always involves some level of risk, and this risk should be considered an implicit cost. If the new product line fails to generate the expected revenue, the business owner will have incurred a significant implicit cost.
- Cost of Capital: When a business owner invests in a new project, they are also tying up capital that could have been used for other purposes. This cost of capital should be considered an implicit cost, as the business owner is effectively giving up the opportunity to earn a return on that capital elsewhere.
- Foregone Benefits: Finally, implicit costs can also include the benefits that could have been earned if the business owner had chosen a different option. For example, if a business owner decides to invest in a new product line, they might forego the benefits that could have been earned by investing in employee training or improving customer service.
Why are Implicit Costs Important?
Implicit costs are important for several reasons. First, they can have a significant impact on a business’s profitability. If a business owner fails to consider the implicit costs associated with a particular decision, they may overestimate the profitability of that decision and make poor investment choices.
Second, implicit cost can help business owners make better decisions by forcing them to consider the opportunity cost of their choices. By thinking about what they are giving up when they invest in a particular project, business owners can make more informed decisions that are more likely to benefit the company in the long run.
Finally, implicit costs are important because they can reveal hidden costs that might not be immediately apparent. For example, a business owner might assume that investing in a new product line will be profitable but fail to consider the implicit costs
types of implicit costs
Implicit costs are costs that are not reflected in accounting records but still have an impact on a business or an individual’s economic decisions. Here are some examples of implicit costs:
- Opportunity cost: The cost of the next best alternative foregone when a decision is made. For instance, if a business owner decides to use their own funds to start a new project, the opportunity cost would be the interest they could have earned by investing the same money elsewhere.
- Foregone wages: When an individual takes time off work to pursue education or to start a new business, they may forego wages they could have earned during that time. This is an implicit cost.
- Depreciation: This is the decline in the value of an asset over time. While it is not a direct cost, it impacts the resale value of the asset and can be considered an implicit cost.
- Interest: The cost of borrowing money is an explicit cost, but the interest foregone by not investing money is an implicit cost.
- Economic profit: This is the difference between total revenue and all implicit and explicit costs, including the opportunity cost of the entrepreneur’s time and resources.