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An explicit cost is a payment associated with running a business, which can be clearly defined and identified. Explicit costs reduce the profits a business makes by eating into the company's bottom line. Some examples include rents, utility payments, wages, materials, services, and taxes. All of these costs are concrete and can be easily accounted for in financial statements. By contrast with an explicit cost, an implicit cost is a more nebulous cost associated with the cost of a missed opportunity for the business or the owner.
Some explicit costs are fixed and contracted. Rents are an excellent example of this type of cost. When a business rents a facility, it sets up a contract that establishes the terms of the rental, and this contract includes fixed payments to the landlord. It may be possible to renegotiate rents and change the terms of the contract in the future. An explicit cost, such as a utility bill, tends to be recurring just like rents and can be fixed or variable, depending on the utility involved.
Other explicit costs are one-time expenses. If a business invests in new equipment to replace aging or outdated equipment, this is a type of explicit cost that only occurs once. Likewise, businesses may pay on single occasions for services such as legal or accounting services that provide a benefit to the business. Services like these may recur at variable interviews; a small company may periodically consult a lawyer, for example, but not keep an attorney on retainer.
With explicit costs, it is easy to see the purpose of the expense and to track outflows. This is used in accounting statements to summarize the financial position of the business and show whether it is earning money or taking a loss. These outlays of funds can benefit the business in the long term and are part of the operational costs of doing business. Companies must spend money in order to function and must also be able to make decisions about incurring additional expenses that will allow them to expand and grow.
Implicit costs, by contrast, are costs associated with choices the business makes. No money changes hands, but a company has lost opportunities and this leads to decreased profits. An example of an implicit cost can be seen when a company volunteers services for a day for a public cause. This represents a day of lost paid work, although it has other benefits such as building goodwill in the community. Lost investment opportunities as a result of having funds tied up in the business are another example of an implicit cost. This type of cost is harder to calculate than an explicit cost.
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