Opportunity Costs

Opportunity Costs

See also:
Decision Making
Opportunity Cost Definition

Opportunity Costs Definition

In economics, opportunity costs refer to the value of the next-best alternative use of that resource given limited resources. They are applicable beyond finance and accounting. In daily life, opportunity costs are the benefits or pleasures foregone by choosing one alternative over another.
For instance, if you decide to spend money eating out for dinner in a restaurant, then you forgo the opportunity to eat a home-cooked meal. You also lose the opportunity of spending that money on another purchase. If the next-best alternative to eating out is eating at home, then the opportunity cost of eating out is the money spent. In addition, another opportunity cost is the experience you forgo by not eating a home-cooked meal. In other words, the opportunity cost is the value of the next best use of your resources. When resources are scarce, consider the cost between alternatives. Do this so that resources (such as time, money, and energy) are used as efficiently as possible.


[button link=”https://strategiccfo.com/internal-analysis” bg_color=”#eb6500″]Download The Internal Analysis Whitepaper[/button]


Opportunity Costs for Production

Opportunity costs apply to allocating resources in production. In economics, the production possibility frontier (PPF) refers to the point of allocating resources and producing goods and services in the most efficient way possible. If the economy produces quantities of goods below or above the PPF, then infer that resources are being allocated inefficiently. The PPF illustrates that opportunity costs exist when deciding what quantity of goods and services to produce in order to maximize efficiency and production capacity. Companies use opportunity costs in production to make smart decisions by weighing the sacrifices of choosing one alternative over another.

Explicit Costs

Explicit costs are opportunity costs when producers make direct payments for expenses such as salaries and wages of employees, rent and utility expenses, and material costs. For example, a company has a $10,000 rent expense. The opportunity cost of $10,000 could have been spent on other aspects of business operations.

Implicit Costs

Implicit costs are opportunity costs when you use an asset instead of selling or renting the asset to someone else. These opportunity costs exist without any actual payments. Economic profit takes implicit costs into account as an extra opportunity cost when you subtract both explicit and implicit costs from total revenues. Accounting profit only takes explicit costs into account when subtracting explicit costs from total revenues.

Opportunity Costs for Consumption

Opportunity costs apply to allocating resources in consumption. If you decide to spend money on a purchase, then you forgo the opportunity to spend that money on other purchases.

Example

For example, a homeowner decides to use his guest quarters over the garage to create a home office. The opportunity cost of the homeowner’s decision is either:

  • the loss of that guest quarters space for visiting family or friends
  • the potential money earned from renting out the space

Check out our free Internal Analysis whitepaper to assist your leadership decisions as your enhance your strengths and resolve your weaknesses.

opportunity costs
[box]Strategic CFO Lab Member Extra
Access your Exit Strategy Checklist Execution Plan in SCFO Lab. The step-by-step plan to put together your exit strategy and maximize the amount of value you get.
Click here to access your Execution Plan. Not a Lab Member?
Click here to learn more about SCFO Labs[/box]

opportunity costs

ARTICLES YOU MIGHT LIKE

The Struggles of Private Company Accounting

Hiring the right accountant  When I meet a business owner operating at a successful $10 million in revenue, they often mention, “My CPA”… I immediately know that CEO/Entrepreneur is referring to their Tax CPA.  That is because one thing that all Entrepreneurs have in common is that they must file a tax return.  So, from

Read More »

IN CRISIS? GET A STRATEGIC CFO! – CEO Blindspots Podcast

Friend of the firm, Birgit Kamps, recently had Strategic CFO President, Dan Corredor, as a guest on her podcast, CEO Blindspots. CEO BLINDSPOTS HOST: Birgit Kamps. She was speaking five languages by the age of 10, and lived in five countries with her Dutch parents prior to becoming an American citizen. Birgit’s professional experience includes starting

Read More »

SHRM calls ICHRA the 401K for Group Health Benefits

Fed-up with group health insurance? ICHRA is the new way to offer great health benefits and avoid ACA penalties, SHRM calls it the 401K for group health benefits.  In 2020 the Department of Labor, HHS and IRS changed the rules for employer health benefits. They changed the Affordable Care Act mandates and penalties for every

Read More »

JOIN OUR NEXT SERIES

Financial Leadership Workshop

MARCH 28TH-31ST 2022

SHARE THIS ARTICLE

JOIN THE NEXT STRATEGIC CFO™ SERIES

Strategic CFO™ Financial Leadership Workshop
The Art of the CFO®

Days
Hours
Min

September 12-15th 2022