What Is an Implicit Cost?
Let me explain what an implicit cost really is. It's a cost that doesn't involve any money changing hands, and you won't see it listed as a separate expense in your books. Essentially, it's an opportunity cost that comes up when your company uses its own assets for something specific. There's no direct payment for using those assets, so no cash is exchanged, and no extra revenue comes in.
What this means for you is that by using your resources this way, you're giving up the chance to make money by letting someone else use them. In simple terms, an implicit cost is what happens when you choose to use an asset yourself instead of renting it out or selling it.
Key Takeaways
Implicit costs are about losing out on income, but they don't mean you're losing profit. They stand in contrast to explicit costs, which are the actual expenses your company pays out during operations. For instance, think of a small business owner who skips taking a salary in the beginning to pump up revenue—that's a classic implicit cost.
Understanding Implicit Costs
You might hear implicit costs called imputed, implied, or notional costs. They're not straightforward to measure, and companies don't usually record them in accounting because no money is actually exchanged. These are losses of potential income, not profits, and they're a form of opportunity cost— the benefit you miss by picking one option over another.
For example, if your company could rent out its building for income but decides to use it for manufacturing instead, that's an implicit cost. You might want to factor these into your cost of doing business since they point to possible income sources. Economists add both implicit and explicit costs when figuring total economic profit, which is your revenue minus expenses and opportunity costs.
In corporate finance, you should always consider implicit costs when deciding how to use your resources.
Implicit Costs vs. Explicit Costs
Implicit costs aren't actually incurred in a way you can measure precisely for accounting, and there's no cash going out. But they're worth thinking about because they help you make better decisions. Explicit costs, on the other hand, are real cash payments for things like rent, salaries, and operating expenses—they show up on your financial statements.
The big difference is that implicit costs are opportunity costs, while explicit costs come from your company's tangible assets like cash. That's why implicit costs are like imputed costs, and explicit ones are out-of-pocket. When calculating economic profit, you use both, but accounting profit only looks at explicit costs.
Examples of Implicit Costs
Consider things like losing interest on funds or machinery depreciation for a project—these are implicit costs. They can also be intangible, like when an owner spends unpaid time maintaining the company instead of earning elsewhere.
If you hire a new employee and have an existing one spend eight hours training them, the implicit cost is that existing employee's hourly wage times eight, because they could have been generating revenue otherwise. Another case is small business owners who forgo salaries early on to cut costs and increase revenue—their skills become an implicit cost to the business.
Are Implicit Costs Always Bad?
No, they're not always bad. Sometimes, the implicit cost of using what you already own is lower than the explicit cost of buying or renting new resources.
What Are Examples of Explicit Costs?
Explicit costs are straightforward operational expenses tied to profitability, such as wages, utilities, advertising, raw materials, and rent.
Is Labor an Implicit Cost?
Labor can be both. When you pay wages or salaries, it's an explicit cost. But if someone like an entrepreneur forgoes pay to start their business, that labor becomes an implicit cost.
The Bottom Line
Implicit costs are opportunity costs not typically recorded in accounting. They represent lost income, but not lost profit, since their value supports the business. Though subjective and hard to quantify, they can be crucial for your business's success.
