Implicit cost

Implicit cost is the amount that could have been earned if a different path had been chosen. For example, a consulting firm wins two contracts with customers, but only has enough staff to handle one of the projects. The firm chooses to accept the contract with customer A. The implicit cost of this project is the profit that the firm would have earned if it had instead gone with customer B.

As another example, George wants to become a writer, so he blocks out a year to write a book. During that time, he could have been earning $80,000 as a consultant. At the end of the year, he earned a $20,000 advance by selling the book to a publisher. The implicit cost of the decision to write a book was $80,000, which he should offset against his $20,000 of earnings.

As yet another example, Sally has $100,000 of cash. She could invest it at a 3% interest rate for the next year, which would earn $3,000. She instead chooses to use the money for a land purchase, on which she will grow grape vines and eventually produce wine. The implicit cost of this decision is $3,000 per year, which is the foregone interest income.

In short, implicit cost is the profit that was sacrificed in order to employ resources elsewhere. Implicit cost is not recorded in the accounting records of a business, and so does not appear in its financial statements. Implicit costs should always be considered when choosing among different alternatives for the deployment of resources. Thus, the concept is most frequently considered during the process of capital budgeting, or when investing excess funds or when assigning tasks to employees.

Similar Terms

Implicit cost is also known as opportunity cost.

Related Courses

Financial Analysis