What is Explicit Cost
An explicit cost is a cost that occurs, is easily identified, and is accounted for in business documents or financial statements. It represents clear, obvious cash outflows that reduce a business's bottom-line profitability. Examples of explicit costs would be items such as wage expenses, rent, or lease costs; it is easy to identify the sources of those cash outflows and the business activities to which the expenses are 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, with their objective dollar amounts 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 purchased equipment 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, also known as accounting costs, involve tangible assets and monetary transactions and result in real business opportunities. Explicit costs are easy to identify, record, and audit because of their paper trail. Contrastingly, implicit or implied costs are not clearly defined, identified, or reported as costs. They often deal with intangibles and are described as opportunity costs. An example of an implicit cost is wasted time. 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, the value of the best alternative not accepted. Explicit cost 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.