What is an 'Explicit Cost'
An explicit cost represents clear, obvious cash outflows from a business that reduce its bottom-line profitability. This contrasts with less-tangible expenses, such as goodwill amortization, which are not as clear cut regarding their effects on a business's bottom-line value. Good examples of explicit costs would be items such as wage expense, rent or lease costs as it is easy to see the source of the cash outflow and the business activities to which the expense is attributed.
BREAKING DOWN 'Explicit Cost'
An explicit cost is an expense that has occurred and has a clearly defined dollar amount. These expenses are incurred during business operations and are actual out-of-pocket cash outlays. The objective dollar amounts are subject to reporting.
Examples of Explicit Costs
Net income of a business reflects residual income remaining after all explicit costs have been paid. Explicit costs are the only costs necessary to calculate accounting profit. Expenses relating to advertising, supplies, utilities, inventory and equipment actually purchased are examples of explicit costs. Although the depreciation of an asset is not an activity that can be tangibly traced, depreciation expense is an explicit cost because it relates to the cost of the underlying asset that the company owns.
Explicit Costs vs. Implicit Costs
Explicit costs arise based on what has actually been purchased as opposed to implicit costs that arise based on what has actually been given up other than money. Explicit costs have a paper trail and provide audit documentation. Implicit costs are not traceable in a financial system. While management will utilize explicit costs when viewing business operations, implicit costs are only utilized in decision-making or choosing between multiple alternatives.
Explicit costs are used in the computation of opportunity costs. An opportunity cost is the total value of an item forgone. It is calculated by adding the explicit and implicit costs of not performing an activity. For example, the purchase of a vehicle by a business represents an explicit cost as the equipment is actually purchased. An implicit cost is the greatest benefit that could have resulted from the use of the funds. This cost could reflect a different vehicle that could have been purchased or the benefit gained from using the funds elsewhere.
Explicit costs are also utilized in the calculation of economic profit. Economic profit is the total return a company receives based on all costs incurred to attain that revenue. These costs include all explicit and implicit costs. Economic profit is utilized for long-term decision-making. Economic profit is used extensively to determine whether a business should enter or exit a market or industry.