Implicit Cost

What is an implicit cost?

An implicit cost is an opportunity cost that arises when a firm uses resources it already owns instead of renting, selling, or employing them elsewhere. No cash changes hands and the cost does not appear as an expense on financial statements, but it represents income the firm forgoes by choosing one use over another.

How it works

Implicit costs reflect the value of the next-best alternative use of an owned resource.
Economists include implicit costs, along with explicit costs, when calculating economic profit:
Economic profit = Revenue − Explicit costs − Implicit costs
Accountants typically record only explicit (cash) costs; implicit costs are not shown on standard financial statements.
Considering implicit costs is important for resource-allocation and investment decisions because they reveal hidden trade-offs.

Implicit vs. explicit costs

Implicit costs:
No cash outflow
Represent opportunity costs (imputed or notional)
Not usually recorded for accounting purposes
Explicit costs:
Actual cash payments (wages, rent, utilities, materials)
Recorded on financial statements
Use cases:
Economic profit uses both implicit and explicit costs.
Accounting profit uses only explicit costs.

Examples

Owner’s forgone salary: A small-business owner works without pay during startup. The unpaid labor is an implicit cost equal to the salary they could earn elsewhere.
Using an owned building: If a company uses its own building for production instead of renting it out, the forgone rental income is an implicit cost.
Forgone interest: Funds used in the business rather than invested elsewhere generate an implicit cost equal to the interest income foregone.
Training time: If an existing employee spends eight hours training a new hire, the implicit cost is roughly eight hours of that employee’s usual wage (income they would otherwise help generate).
Opportunity-based depreciation: Choosing to use existing machinery for a new project instead of selling or renting it out implies a cost in lost alternative income.

Common questions

Are implicit costs always bad? No. Using owned resources may be cheaper than paying for alternatives, so the implicit cost can be lower than the corresponding explicit cost.
Is labor an implicit cost? It can be both. Paid wages are explicit costs; unpaid owner labor or foregone salary is an implicit cost.

Key takeaways

Implicit costs are opportunity costs without cash transactions and are not usually recorded in accounting.
They are essential for evaluating economic profit and making informed allocation decisions.
Managers should consider implicit costs alongside explicit costs when assessing the true economic return of projects and resource uses.