Implicit Cost

What Is an Implicit Cost?

An implicit cost is an opportunity cost that does not show up as a payment in a company's accounting records. When a business uses its own money, buildings, equipment, or the owner's time, it gives up the chance to use those resources somewhere else. Economists count that forgone benefit as a real cost, even though no check is written and no invoice arrives.

Implicit costs are the opposite of explicit costs, which are actual cash outlays such as wages paid to employees, rent paid to a landlord, or money spent on raw materials.

How Implicit Costs Work

The idea rests on the concept of opportunity cost: the value of the next-best alternative you give up when you make a choice. If a business owner puts $100,000 of personal savings into their company instead of investing it elsewhere, the return that money could have earned is an implicit cost of running the business. The same logic applies if an owner works in the business without drawing a salary, or if the company uses a building it owns rather than renting it out.

Accountants and economists often measure these costs differently. Standard accounting records mainly explicit costs, so a business can show a profit on its financial statements while still having a lower economic profit once implicit costs are subtracted.

An Example

Suppose a small bakery owner runs the shop full-time and does not pay herself a salary. She could have earned $50,000 a year working for another employer. Her accounting statements may show no wage expense at all, but from an economic standpoint, that forgone $50,000 is an implicit cost. If the bakery earns $60,000 after all explicit costs, its accounting profit is $60,000, but its economic profit is only $10,000 once her forgone wages are counted.

Why It Matters to Investors

Implicit costs help explain why a company that looks profitable on paper may not be creating much value beyond what its owners could earn elsewhere. Investors reading financial statements should keep in mind that these statements capture explicit costs and generally omit implicit ones. Comparing returns to a cost of capital, which reflects what investors could earn on similar risk, is one way to account for the implicit cost of equity funding.