What Is The Implicit Cost-You Should Know
When a company is running its business operations it has to incur certain unavoidable expenses. These are referred to as implicit costs. These costs are also referred to as implied costs and they may refer to resources that could impact the overall operating profit. But when it comes to finding out the overall economic profitability of any organization or business, you must take into account both implicit cost and also explicit cost. Understanding the importance of both these costs is important and it would also be better if we have a reasonably good understanding as far as implicit vs. explicit costs are concerned.
What Exactly Is Implicit Cost?
When we talk about implicit cost, we are referring to an opportunity cost where the organization makes use of the resources that it already owns. The resources and the necessary implicit costs are often contributed by the promoters of the company. Alternately, it is paid from the pockets or other sources. These could include the costs incurred for the construction of a building that will be used only for business purposes rather than trying to generate some rental income out of it. Some more examples of the implicit cost could be the depreciation that takes place on goods or assets, and also the expenses incurred for procuring and buying equipment and materials that are required for running business operations. Implicit costs also could include various costs that may not have been there if the firm was to make use of these to generate revenue.
Why Is Implicit Cost Important?
Implicit cost is important because it is a key factor that could help in knowing more about the overall success of a company. Implicit costs also take into account resources that are underutilized but also may include the possible losses if the resources were not used to generate additional revenue. Hence, often these costs are referred to as imputed, or notional cost. Often the costs maybe not too easy to quantify. Many businesses may not accurately keep a note of implicit costs as far as their accounting practices and processes are concerned. This is because often funds are not exchanged directly and it also could be a notional loss of income, but not profit. Some companies, however, have the practice of reporting implicit costs because it could represent an alternative source of income.
What is Explicit Cost?
If we are to understand the implicit cost properly, it is important that we also have a fair idea about explicit cost. Explicit cost refers to the expenses that a company may have paid for. A few examples of explicit costs are wages, employee salary, office rental, stationary expenses, telephone bills, etc. However, when it comes to finding out the accounting profit and the overall economic health of the company, however, big or small it may be.
What are the Differences between Implicit Cost & Explicit Cost?
Though there could be many differences between implicit and explicit cost, the biggest difference is having a fix on the overall profit concepts. Explicit costs are arrived at by subtracting the costs from the total revenue of the company. This helps in arriving at the accounting profit of the company. Accounting profit does not usually take into account implicit costs. Therefore, many accountants and financial experts believe that accounting profit is a rather simplistic way of looking at the overall profitability of a company. It may not be the right indicator of the overall economic health of the company and how it stands vis-à-vis the market.
Further, we also need to understand that the exact economic profit of a company is derived through a complex process. It is about subtracting the overall total cost and this should include both explicit and implicit. This is deducted from the total revenue reported by a company. This could be a better way of looking at the overall economic performance of the company and it could throw light on the true profitability because the implicit cost has been deducted from the overall revenues of the company. We have to bear in mind that accounting profit could throw light on the total income and the tax liability on such incomes, professionally managing companies would be interested to know more about the overall economic success rather than looking at some rough numbers.
The Final Word
It is clear from the above that there are some basic differences between implicit cost and explicit cost. While explicit cost is determinable, the implicit cost has to be deduced and calculated. What is important is that the implicit cost should also be factored in while calculating profits because it helps in understanding the actual economic health and well-being of the company.