Implicit cost definition
/What is Implicit Cost?
Implicit cost is the income sacrificed when resources are used for one alternative instead of another. A consulting firm with staff for only one project chooses customer A over customer B. The implicit cost is the profit forgone from customer B. Implicit costs are not recorded in accounting records or financial statements but are important in resource allocation, capital budgeting, investing excess funds, and assigning employees. They also influence strategic decisions because committing resources to one business area limits their availability elsewhere.
Example of Implicit Cost
Here are several examples of how the implicit cost concept can be used in decision-making:
Alternative uses for an asset. A business owner operates a retail shop in a building they already own, rather than renting it out. While they don’t pay rent to anyone else, they forgo potential rental income—say $5,000 per month—that the space could have generated. That lost income is an implicit cost of using the building for the shop. It’s important for the owner to factor this in when assessing whether the space is being used efficiently.
Alternative uses of labor. 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.
Alternative uses of money. 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.
Implicit Cost FAQs
How do implicit costs differ from explicit costs?
Implicit costs represent the opportunity costs of using resources the business already owns, without any cash payment. Explicit costs involve actual cash outflows for wages, materials, or services purchased from outside parties. Together, they form the total economic cost of operating a business.
Terms Similar to Implicit Cost
Implicit cost is also known as opportunity cost.