What is an Implicit Cost?

What is an Implicit Cost?

Definition

An implicit cost is a type of opportunity cost for utilizing a company’s assets. It cannot be easily measured and does not result in any payment being made. Instead, it is a notional expense that results in a loss of possible income.

What does implicit cost mean?

An implicit cost is incurred when a firm adopts a particular course of action that prevents it from utilizing its productive resources in some other manner. To understand this point, consider a situation where a company owns a factory building. It uses this structure to manufacture the goods that it produces.

As the building is owned, the firm does not need to pay rent for its use. However, if the building was rented out to a tenant, the company could have earned a certain sum every month. Let us assume this amount to be $1,000. This is the implicit cost that the firm is incurring on a monthly basis. It does not find a place in the books of account, but it does represent a loss of income for the company.

Another feature of an implicit cost is that it is hard to measure. In the example that we have taken, we have assumed an implicit cost of $1,000 per month. But the rent for the building could be $1,200 or $800. The company cannot know the real figure unless it rents the building to a tenant.

Example of an implicit cost

Greenwich Bakery is a sole proprietorship owned by Tim Langwood. The business does not have any employees, and Tim and his wife, Joyce, who helps by maintaining the financial records, manage the entire operation.

Tim can easily get a job at a neighboring factory at an hourly wage of $20. If he takes up this work, he can earn about $40,000 per year. This sum is an implicit cost for Tim’s bakery business. Although it does not involve any payment, it is the amount that is being forgone by Tim.

Summary

Implicit costs do not find a place in a firm’s financial records. But they should be considered to make business decisions.