Question

Differentiate between the firm's implicit and explicit cost and discuss the firm’s variable and fixed costs. For your chosen industry please express whether your firm is economically viable or not. Is your firm profitable? Do they have an optimistic or uncertain outlook for the near future?

Answer 1

Based on payment, costs are classified into two categories; they are Explicit Costs and Implicit Costs. Explicit Cost is the cost which is actually incurred by the organization, during production. On the other hand, Implicit Cost, are just opposite to the explicit cost, as the organization does not directly incur them, but they are implied in nature which does not involve a cash payment. The former is an out of pocket cost, while the latter is an opportunity cost.

Explicit Cost refers to the one paid to the factors outside the firm. Conversely, Implicit Cost are the one that arise from using the asset rather than renting it out. There are a number of differences between explicit cost and implicit cost, which has been explained in the article presented below, have a look.

Explicit Costs are the costs which involve an immediate outlay of cash from the business. The cost is incurred when any production process is going on, or activity is conducted in the normal course of business. The cost is a charge for the use of factors of production like land, labour, capital and so on. They are in the form of rent, salary, material, wages, and other expenses like electricity, stationery, postage, etc.

Explicit Costs show that payment has been made to outsiders, while business is carried on. The recognition and reporting of the explicit cost are very easy because they are recorded when they arise. They show that an amount has been spent over a business transaction. They can be calculated in terms of money.

Recording of the explicit cost is very important because it helps in the calculation of profit as well as it fulfils purposes like decision-making, cost control, reporting, etc.

Implicit Cost, also known as the economic cost, is the cost which the company had foregone while employing the alternative course of action. They do not involve any outflow of cash from the business. It is the value of sacrifice made by the entity at the time of exercising some other action. The cost occurs when an asset is used as a factor of production by the entity instead of renting it out.

As they are not actually incurred they cannot be easily measured, but they can be estimated. They are not recorded in the books of accounts as well as these are not reported. The purpose of ascertaining the implicit cost is that it helps in decision making regarding the replacement of any asset and much more.

The following are the major differences between explicit cost and implicit cost

1. Explicit Cost is incurred when the entity has to pay for the utilisation of factors of production. Implicit Cost is the opportunity cost, which is incurred when the entity uses the owner’s resources like capital inventory etc.
2. Explicit Cost is also known as out-of-pocket cost while Implicit costs are known as imputed cost.
3. Explicit Cost can be easily ascertained, but it is just opposite in the case of Implicit Cost as it does not have any paper trail.
4. The measurement of Explicit Cost is objective in nature because it is actually incurred whereas Implicit Cost occurs indirectly and that is why its measurement is subjective.
5. Explicit Cost helps in the calculation of both accounting profit and economic profit. Conversely, Implicit Cost helps in the calculation of only economic profit.
6. Explicit Cost is recorded and reported to the management. On the other hand, the implicit cost is neither recorded nor reported to the management of the company.

Variable Costs and Fixed Costs

All the costs faced by companies can be broken into two main categories: fixed costs and variable costs.

Fixed costs are costs that are independent of output. These remain constant throughout the relevant range and are usually considered sunk for the relevant range (not relevant to output decisions). Fixed costs often include rent, buildings, machinery, etc.

Variable costs are costs that vary with output. Generally variable costs increase at a constant rate relative to labor and capital. Variable costs may include wages, utilities, materials used in production, etc.

In accounting they also often refer to mixed costs. These are simply costs that are part fixed and part variable. An example could be electricity--electricity usage may increase with production but if nothing is produced a factory still may require a certain amount of power just to maintain itself.

Entrepreneurs hoping to secure a partner to bankroll their R&D efforts or market their products are wasting their time if they do not have a viable business already in place. If the small company's business practices are shoddy, disorganized, or incomplete, large companies will be sure to notice.

The trappings of the corporate world (high-rise buildings, cavernous conference rooms, legions of blue suits, etc.) can be intimidating, but small business owners have to remember that they run viable businesses of value themselves, and they should negotiate accordingly.