Implicit costs are any resources that may be underutilized for generating profit. When a company or business endures operations such as opening new headquarters or taking a loss on earnable wages, it will notice the effects of implicit costs. Implicit cost represents the opportunity cost of using resources a company already has. Implicit costs often come from the owners of a company or out-of-pocket costs. An example of an out-of-pocket cost is a building used for business operations instead of generating rental profit. Implicit costs can include the depreciation of assets, goods, materials, and equipment a business needs. Also, implicit costs represent expenses that would not exist if a firm utilized all of its resources.
What is Implicit Cost?
An implicit cost is any expense that has already been incurred but is not specifically stated or recognized as a distinct expense. It represents an opportunity cost when a company uses internal resources for a project without explicit compensation. Suppose a company properly uses all of its resources. In that case, it will always lose the ability to earn money off of the resources somewhere else. If a manager needed to train their staff and it required 8 hours of their time, the implicit cost would be their time. The 8 hours the manager put toward training could be applied to other daily tasks. Implicit costs exist without the exchange of cash and are not recorded for accounting purposes.
What is the importance of Implicit Cost?
The importance of implicit costs is that they are crucial in gauging a company’s overall economic success. Implicit costs consider not only underutilized resources but a business’s incurred loss if it chooses not to use its resources to gain more revenue. Professionals call implicit costs implied, notional, or imputed costs too. That is because these types of costs can be challenging to quantify. A business may not document implicit costs for accounting reasons since funds are not directly exchanged. Additionally, implicit costs may represent a potential loss of income but not always profit.
Where do Implicit Costs appear?
Implicit costs do not appear on accounting records. Implicit costs are non-monetary and usually difficult to quantify. Therefore, they are not considered a crucial part of a company’s regular accounting. If a business owner received a regular salary to operate a business, the salary they receive for work they performed would be an explicit cost to the corporation. However, if a small business owner does not receive a salary but takes a management fee or dividends for work they perform, that would be an implicit cost. The income statement would not highlight the owner’s efforts or cost.
What are examples of Implicit Costs?
Implicit costs tend to be complex since they deal with intangible costs. Implicit costs represent opportunity costs and are associated with what would happen if you took a certain action. Implicit costs come from using an asset instead of purchasing or renting an asset. You do not track implicit costs like expenses in record books. You can calculate implicit costs to gauge economic profit and help make smart business decisions.
There are three examples of implicit costs. They are common opportunity costs people weigh in a company.
- Losing financial interest
- Educating a new hire
- Attending a university
1. Losing financial interest
Implicit costs do not only serve as a negative, profit-reducing signal for businesses. For instance, a business may accrue an implicit cost of $10,000 by utilizing its existing resources. But by making this decision, it may avoid incurring an explicit cost of $15,000. The $15,000 is the price it will need to pay for using outside resources. A company could see a positive net accounting profit. Still, once implicit costs are factored in, it could be a losing economic enterprise.
2. Educating a new hire
Educating a new hire requires explicit and implicit costs. The explicit costs would be the cost of placing a job advertisement for the opening or paying for an applicant to travel to company offices for interviews. Implicit costs include the time a president or owner has to spend interviewing the applicant. The president or owner is gaining no monetary value for interviewing various candidates. They are sacrificing something intangible to find the perfect fit for their company. Most companies have to make this opportunity cost eventually.
3. Attending a university
Maintenance is another intangible cost for various business projects. Suppose an owner allocates time toward the maintenance of a company. They miss out on the chance to use those hours for something else. Most of the time, implicit costs are not reserved for accounting purposes. The maintenance of a company is important, but there are several other needs that business owners must address. By addressing concerns with machinery or other items that need improvement, something else might fall behind.
4. Maintenance
Maintenance is another intangible cost for various business projects. Suppose an owner allocates time toward the maintenance of a company. They miss out on the chance to use those hours for something else. Most of the time, implicit costs are not reserved for accounting purposes. The maintenance of a company is important, but there are several other needs that business owners must address. By addressing concerns with machinery or other items that need improvement, something else might fall behind.
How to calculate Implicit Cost?
- First, understand that implicit costs do not appear on financial records. They are the opposite of explicit costs, which are out-of-pocket expenses accrued on business activities and operations.
- Second, implicit costs are intangible and more focused on sacrifices and other options someone loses in favor of something else. For instance, if a company would risk economic profit by renting out a fixed asset, the option to rent the asset would be an implicit cost. There is no purpose in renting the asset if it is not utilized correctly and causes economic trouble.
- Third, some implicit costs are the time and resources invested in training an employee and equipment depreciation. None of these things directly affect financial records, but they still impact a business overall.
- Fourth, to truly calculate implicit costs, you must perform a scenario or comprehensive comparative analysis to gauge the overall impact of a situation. There is no fixed mathematical equation for implicit costs. Implicit costs have no concrete basis.
Are Implicit Costs Important?
Implicit costs are important since they determine the economic profit a business earns. The economic profit is gauged by the difference in total revenue earned by the business with the sum of explicit and implicit costs. Businesses have to determine implicit costs by employing scenarios and comparative analysis of the options available to them. Economists closely observe implicit costs relating to the business and usually form them as a part of their economic analysis. Implicit costs are crucial to operational businesses and economists who analyze the nation’s economy.
What is the difference between Implicit Cost and Explicit Cost?
The difference between implicit and explicit costs is how they impact a business and are recorded. Explicit costs are regular business expenses that appear on the general ledger and directly affect a company’s profitability. On the other hand, implicit costs deal with intangible things. They are opportunity costs, which means they are associated with what would happen if you do something (make an investment). Explicit cost examples are employee wages, lease payments, utilities, and supplies. They are accounting costs that are easy to identify, track, and record. Some examples of implicit costs would include the annual cash flow from stocks if you sold your business and the time spent on one business activity. In essence, implicit cost results from the possible use of an asset instead of the purchase or rental of it.
