Why is explicit cost important?
The explicit cost is significant for a number of reasons, including:
What is explicit cost?
A payment made to another party in the course of operating a business that clearly and unmistakably shows the outflow of cash Wages, rent, utilities, mortgages, utilities, advertisements, raw materials, and other general, administrative, and sales costs are examples of explicit costs. Explicit costs must be paid for in cash in order to be considered. It would be incorrect for an accountant to include amortization or depreciation under explicit costs. Here is a look at how explicit costs are calculated:
Explicit costs = cash outflows from the companys financial statement
These expenses are in the expenses listed on the income statement and are typically simple to identify in the general ledger.
How is explicit cost different from implicit cost?
Explicit costs are payments that are made in-person, like salaries and rent. Implicit costs are opportunity costs associated with allocating resources for a particular use that are difficult to quantify in terms of money. They frequently deal with intangibles and are not clearly identified, defined, or reported. An implicit cost is the time needed to train a new employee and time spent on business activities that could be used more effectively elsewhere. Opportunity costs are frequently hidden costs caused by forgoing the best option available.
An example of an implicit cost would be the loss of the opportunity to sell and profit from the refrigerators if an appliance company was considering investing in a new line of refrigerators to sell but decided to put the same amount of money into an employee training program instead.
Costs will oftentimes have both explicit and implicit portions. The cost of the repair technician and any parts required, for instance, are explicit costs if the printer at the printing company breaks down. However, the lost production time as a result of the break down is an implicit cost.
The total economic cost is equal to the sum of the explicit and implicit costs.
Management will use explicit costs to calculate the business profitability when assessing an operation. However, management may use implicit costs when making decisions or selecting between various options. Management will assess the total return a company receives on all costs associated with revenue using both explicit and implicit costs.
For instance, if a person decides to leave work for an hour to buy office supplies, and the supplies cost $200, the explicit cost is $200. But if that person earns $25 per hour at their job and is absent from work while performing their duties, the business also lost $25. Therefore, the actual economic cost of the supplies is $225.
Examples of explicit cost
Here are some explicit cost examples you could use to determine your accounting profit:
Examples of implicit costs
Here are a few instances of implicit costs that your company might experience:
How to calculate total economic profit
Follow these steps to calculate the total economic profit:
1. Determine explicit costs
These may consist of your rent, mortgage, utilities, and other costs. To calculate the total explicit costs for the business, add up all of your costs.
2. Determine revenue
Find out your company’s overall revenue using your general ledger. This figure represents the revenue that the company brought in. It is typically stated as revenue, net sales, sales, or net revenue on the first line of the income statement.
3. Determine implicit costs
Identify what the potentially missed opportunities could be. For instance, the loss of potential income would be an implicit cost if starting a new business required you to leave your current job. You might need to assign a monetary value to the lost leisure time and deduct that amount from the economic profits.
4. Subtract costs from profit
Your total economic profit will be determined by deducting your explicit and implicit costs from the total revenue of the company.
Explicit versus Implicit Costs | Microeconomics
FAQ
What is explicit cost?
Explicit costs are out-of-pocket costs—payments that are actually made. Explicit costs include salaries that a company pays to its employees and office rent. Implicit costs are more subtle but just as important. They stand for the opportunity cost of using resources the company already owns.
What is implicit and explicit cost?
Implicit costs, or opportunity costs, are the primary distinction between the two types of costs, whereas explicit costs, or expenses incurred using a company’s own tangible assets, are those costs. As a result, implicit costs are also known as imputed costs, whereas explicit costs are referred to as out-of-pocket costs.
What is an example of implicit cost?
Knowing your business expenses will make it simple to calculate explicit costs. Add up all of your business expenses on the general ledger to determine explicit costs. Once more, these could be things like rent, insurance, supplies, equipment, and the cost of goods sold. Keep in mind that expenses vary from business to business.
