Implicit vs Explicit Costs

These are the 2 kinds of costs you need to understand for your business, but if you mix them up, you could end up making a terrible business decision.

When you pay a direct dollar amount for something, that’s called an explicit cost. But there’s another kind of cost that people either forget about or use wrong.

They’re called implicit costs.These are the opportunity cost for using the company’s existing resources.

I talk about opportunity costs in this video, but essentially, if you own a building and use that as your storefront, you’re giving up the money you could make renting it out instead.

But what’s the right and wrong time to actually use each type of cost?

Implicit costs should not be added to the books by financial accountants. When they do factor in implicit costs, you get something called “creative math” and you get another cost called “bail money”. Your Accounting profit is equal to revenue minus only your explicit costs.

But, implicit costs should be considered when making strategic and economic decisions. Economic profit is equal to revenue minus explicit and implicit costs.