Explicit costs can be easily determined and can be invaluable for decision-making in a business or department. In this article, we explain what explicit cost is, why it’s important and how it differs from implicit costs.
What Is Explicit Cost?
Explicit costs are normal business costs that appear in the general ledger and directly affect a company’s profitability. Explicit costs have clearly defined dollar amounts, which flow through to the income statement. Examples of explicit costs include wages, lease payments, utilities, raw materials, and other direct costs.
Explicit costs also referred to as accounting costs, are easy to determine and relate to the operating operations of a corporation to which the expenses are related. They are reported in the general ledger of a corporation and flow to the expenditures listed on the statement of income.
A business’s Net Profit or Net Income (NI) represents the remaining residual profits after all specific expenses have been incurred. Explicit costs are the only accounting costs required to measure a profit, as they have a direct effect on the bottom line of a company. The specific cost metric is particularly useful for the long-term strategic planning of the businesses.
Calculate explicit cost
Calculating explicit costs is simple as long as you know your business expenses. To calculate explicit costs, add together your business expenses on the general ledger. Again, this could include insurance, rent, equipment, supplies, cost of goods sold, etc.
Keep in mind that expenses vary from business to business. So, there is no universal formula for computing explicit costs. But, it’s pretty easy to compute if you have a list of your business expenses at the tip of your fingers.
Explicit Cost Formula
There is no specific formula for computing the explicit cost. It is the aggregate of all the business expenses that leads to cash outflow. We can say that:
Explicit Costs = Cash outflows recorded in the company’s financial statements
- Equipment and machinery purchased for the production of goods and services;
- Salary, wages, commission, bonus, and other monetary compensation paid to employees;
- Other allowances, benefits, and reimbursements—travel, food, accommodation, business trips, and healthcare expenses;
- Rent or lease paid for the property;
- Mortgage payments;
- Electricity, internet, water bills, and other utility expenses;
- Taxes and legal charges;
- Advertisement, sales, and marketing expenses.
Explicit cost example
Say your business has $10,000 in cost of goods sold, $1,000 in rent, $200 in supplies, $300 in insurance, $13,000 in employee wages, and $500 in utility costs for the period. To find your total explicit costs, add together all of your expenses:
Explicit Costs = $10,000 + $1,000 + $200 + $300 + $13,000 + $500
Your total explicit costs add up to $25,000 for the period. You can plug this amount into other formulas, like the accounting or economic profit formulas, to find out financial information for your business.
How is the explicit cost different from the implicit cost?
Explicit costs refer to actual payments, such as wages and rent. Implicit costs represent the opportunity costs that occur from allocating resources for a specific purpose that can’t be assigned a monetary value.
They are not clearly identified, defined, or reported and often deal with intangibles. The time required to train a new employee is an implicit cost, as is time spent on business activities that could be better spent in other ways. Opportunity costs are often implicit costs, with the cost being the act of giving up the next best alternative.
For example, if an appliance company was considering investing in a new line of refrigerators to sell but instead chose to invest the same amount of money into an employee training program, the cost for the missed opportunity to sell and make money off of the refrigerators is an implicit cost.
Costs will oftentimes have both explicit and implicit portions. For example, if the printer at the printing company breaks down, the cost of the repair technician and any parts that are needed are explicit costs, while the lost production time as a result of the breakdown is an implicit cost.
The total sum of the explicit and implicit costs represents the total economic cost.
When evaluating a business’s operations, management will utilize explicit costs to determine the business’ profitability. However, management may rely on implicit costs for decision-making or when choosing between different options. Management will use both explicit and implicit costs to evaluate the total return that a company receives on all costs that are related to revenue.