What is an ‘Implicit Cost’
An implicit cost is any cost that has already occurred but is not necessarily shown or reported as a separate expense. It represents an opportunity cost that arises when a company allocates internal resources toward a project without any explicit compensation for the utilization of resources. This means that when a company allocates its resources, it always forgoes the ability to earn money off the use of the resources elsewhere.
BREAKING DOWN ‘Implicit Cost’
Examples of implicit costs include the loss of interest income on funds, and the depreciation of machinery for a capital project. Implicit costs can also be intangible costs that are not easily accounted for, such as situations in which an owner allocates time toward the maintenance of a company, rather than allocating those hours elsewhere. In most cases, implicit costs are not recorded for accounting purposes.
When a company hires a new employee, for example, there are implicit costs to train that employee. If a manager allocates eight hours of an existing employee’s day to teach this new team member, the implicit costs would be the existing employee’s hourly wage, multiplied by eight. This is because the hours could have been allocated toward the employee’s current role. In corporate finance decisions, implicit costs should always be considered when coming to a decision on how to allocate company resources.
Difference Between Implicit and Explicit Costs
Implicit costs are technically not incurred and therefore cannot be measured accurately for accounting purposes. There are no cash exchanges in the realization of implicit costs. However, they are important costs to ascertain because they help managers make effective decisions on behalf of the company.
This is in stark contrast to explicit costs, the other broad categorization of business expenses. These costs represent any costs involved in the payment of cash or other tangible resource by a company. Rent, salary and other operating expenses are considered explicit costs and are recorded within a company’s financial statements.
The main difference between the two types of costs is that implicit costs are opportunity costs, while explicit costs are expenses paid with a company’s own tangible assets. This makes implicit costs synonymous with imputed costs, while explicit costs are considered out-of-pocket costs. Implicit costs are harder to measure than explicit costs, which makes implicit costs more subjective than explicit ones. Implicit costs help managers calculate overall economic profit, while explicit costs are used to calculate accounting profit and economic profit.